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Exit strategies, particularly the sale of a multi-unit restaurant company, at present are very problematic: (i) multiples are down; (ii) there are fewer strategic buyers; (iii) the IPO market is non-existent; (iv) restaurant industry franchisors are moving more toward franchising than acquisitions; and (v) private equity groups are not necessarily willing to pay attractive multiples.
Given all of the above facts and the importance of an exit strategy, what can the multi-unit restaurant owner do? An MBO.
Management buy-outs (commonly referred to as “MBO’s”) first gained prominence in the 1980’s as the result of the high yield bond market. MBO’s are often a very attractive exit strategy for the multi-unit restaurant company.
The restaurant industry is divided into four sectors. While each of these unique categories of the restaurant industry has its own issues, all may benefit from an assessment of the value of an MBO.
1. Single restaurant operations. An MBO may be the best way to attract talent and the only way to provide for any type of exit strategy.
2. Non-franchise multi-unit restaurant companies. For this group (particularly if there are multiple concepts), management may be the truest evaluator of the intrinsic value of the concepts and therefore, may be the highest priced buyer.
3. Restaurant franchise companies. If a franchisor does not show huge growth potential or significant year-to-year unit sales improvements, the seller market may be very limited. Again, the MBO may be the appropriate approach.
4. Multi-unit franchisee restaurant operator. The limited amount of franchisee financing, unavailability of franchisee to franchisee buyers and the present desire of most franchisors to pursue franchising vs. corporate store ownership may again lead the franchisee to a management buyout.
Given all of this, let’s explore the characteristics of an MBO.
A Few Positive Aspects Of An MBO
1. Most restaurant companies have developed strong management teams that recognize the intrinsic value of the system.
2. The team understands where cost savings can be recognized and are able to create and implement new ideas for growth through the continuity an MBO allows.
3. The team usually is best able to continue the business of the seller without interruption.
A Few Negative Aspects of an MBO
1. Experienced management may lack the objectivity to make changes necessary to move the concept forward or to facilitate the level of growth required to achieve optimum profitability.
2. The management team may have limited human and financial resources to accomplish an MBO, thus diverting existing resources away from operations that could negatively impact sales.
3. An MBO can be very arduous and implementation may be slow.
4. Finally, a failed attempt at an MBO can create significant problems for the restaurant operator as it can create havoc among the employees and cause concern regarding the future of the business.
Factors To Consider When Evaluating An MBO
Once you have decided an MBO may be realistic, following are some things to think about:
1. Is there a strong management team?
2. Will the management team be able to run the company when the owners are gone?
3. Is there new blood in the management team that will be able to bring new and creative ideas that translate into profits enabling the company to repay its debt?
4. Is the management team knowledgeable about sophisticated financial matters?
5. Does the management team have adequate financing to weather economic downturns, growth expenditures and other financial bumps in the road?
6. Has the management team done an MBO before?
7. Does the management team have a suitable financial advisor?
8. Does the management team have senior lender contacts?
9. Is the management team willing to put its own cash into the transaction?
10. Are the owners committed to an MBO from a timing standpoint?
The Process
Once it has been decided to move forward with an MBO, the management team must present an offer that reflects the pricing, structure, financing, closing agreements and post-closing position acceptable to the owners. This offer process can be handled three ways:
1. General Solicitation. The management team is involved in a general solicitation process where they have the opportunity to bid, along with other outside third parties. This, in effect, assures management of a market price and does not back the owners into a corner if the MBO does not work.
2. Owner-Controlled Solicitation. This is a process where the owners provide an exclusive time for management to come up with an offer. The owners may get a fairness opinion to find out exactly what the value of the company should be and whether it is fair for the owners, in general, to pursue an MBO under the proposed terms.
3. Third-Party Controlled Solicitation. This is a modified process whereby an investment banker is used to explore the market. The banker presents the management team with the right of first offer, and makes sure the management team is committed and willing to contribute some up-front money to move the process forward.
Pricing an MBO
An experienced management team understands the intrinsic value of the company and what can happen with new stores, remodels and cost savings. The MBO price is typically higher than a third-party bid because of this inside knowledge of intrinsic value and the desire to keep their jobs. In addition, sophisticated owners (or their financial and legal advisors) can structure the MBO to provide the owners with a more favorable tax treatment than would be available in a straight sale.
Structure of an MBO
“What would an outside buyer do?” is a question that needs to be asked with regard to the MBO structure. The company is normally a newly created entity which either acquires the stock or assets of the target through a stock asset acquisition or a merger. In most cases the MBO company is a flow-through entity for the benefit of the new owners. The MBO may take the form of an ESOP. Even though ESOPs have not often been used in the restaurant industry because of ERISA’s broad participation requirement, this may be an effective tool (particularly for franchisors).
Financing an MBO
The key to financing an MBO is the management team must have equity in the transaction. The days of fully leveraged transactions are gone, and management’s equity is typically more than just a seller note. Generally, there are three components to financing an MBO: senior debt, equity and seller paper.
1. Senior Debt. Senior debt is the amount of financing the restaurant’s assets can support.
2. Equity. Also referred to as capital infusion, equity is normally provided by both the management team and an outside equity group (sponsor). Management teams sometimes use friends and family rather than a sponsor. It is important that the equity interests of both the management team and the sponsor reflect the intrinsic value of the management’s perception of value. In addition, the management team and the sponsor must be compatible and have a clear exit strategy.
3. Seller Paper. Most MBO’s involve some type of owner-held paper. Seller paper is almost always subordinate to senior debt and may, in some cases, be subordinate to the equity investors to some degree.
Conclusion
In conclusion, an MBO may be the best available exit strategy, but the keys to a successful MBO are: (i) a strong management team; (ii) an adequately funded buyout; and (iii) all parties understanding the intricacies of the restaurant industry.
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