By David Baxa, President and CEO VISTA Technology Services, Inc. (Published Apr.26, 2004)

Is a management buyout right for you? Certainly it's an attractive business proposition. This type of growth strategy gives management an opportunity to generate value, and move the business into a new phase of development. It's also an opportunity to enable the company to become better focused on its core business. By separating itself from a parent organization, the management team and their financial backers can be certain that the business goals of the company are no longer diluted by being just one line item in a larger overall balance sheet.

Private equity firms and banks are always interested in entertaining the backing of high quality management buyout transactions. The valuation of the company is usually appealing in a buyout, and the management team has shown initiative in getting something done.

Of course, management buyouts are challenging to complete. They have unique characteristics. Unlike a conventional financing transaction or acquisition, a variety of environmental factors have to be ideal.

VISTA Technology Services, Inc. (VISTA) concluded a management-led buyout of the company at the end of 2003. The result is a wholly Veteran-owned firm that is eligible for more government-mandated contracts than it would have been as part of a larger organization. VISTA is also a more attractive partner now and can enable its government clients and large business partners to fulfill their small business contracting requirements.

Our experience has led us to develop a checklist of questions that any company should consider in following a management buyout growth strategy. If you have positive answers for these questions, you can be confident that your buyout strategy is prepared for success.

Question 1: Are the internal environmental conditions right? The ideal situation for a management buyout is when the parent company is prepared to shut its doors and sell off all company assets. That makes it easier for the management team to step in and make a credible offer that can be taken seriously. When the timing and circumstances are correct, both parties can focus on the primary goal: to get best price.

Internal environment conditions for a successful management buyout don't happen that often. If the management buyout offer creates a hostile, contentious situation with the current ownership, you'll find it's difficult to raise money.

Question 2: Is the business "finance-able"? You need both tangible and intangible assets, as well as a management team that can make the best use of those assets after the transaction has been concluded. History of performance, positive cash flows and profits are all essential factors in financing your buyout.

Before you begin, make sure you have either hard assets that will support a financing base or intangible benefits against which an outside party will be willing to create an equity financing arrangement. Strength of management team, intellectual property, and customer relationships are all important.

In our case, the management team has been together for 15 years, and the leadership was responsible for a successful track record of business development. That, along with a history of revenue growth, proved attractive to management's financial backers.

Question 3: Are there legitimate business benefits for the management team in buying the company? Deciding to be your own boss is not the right motivation to embark on a management buyout. You need to know that you can create a unique value proposition that would not necessarily apply in any other ownership scenario.

The fact that Vista would be a wholly Veteran-owned small business created new business opportunities for us, as well as making us a valuable partner to larger contractors who would otherwise be precluded from consideration for certain government contracts. Likewise, our long-standing client base would gain the benefit of being able to fulfill its federally-mandated small business contracting requirements by working with the newly acquired company.

Don't get started down the road to a buyout without knowing that you have something new to offer the market that couldn't be attained any other way.

Question 4. Are the external conditions right? Here we're specifically referring to capital formation. Before you make any overtures to the current ownership, test the waters with the capital markets to determine what level of financing is possible. This must be done discreetly, because the minute the offer is made to the parent organization, it puts the seller in a bit of a "box" - any other potential buyer would recognize that its offer would not be met with the endorsement of the management team.

Once that happens, the owner either must take a hard line with the management team (discussions of separation can sometimes be the consequence for the team) or must embrace the proposed transaction and promote it. That's why you need to know how much you can raise upfront - so that if you put your owners in a box you can help them out with a credible offer that's supportable by outside financing.

We spoke with several commercial banks and private equity firms to know what level of financing was possible, and at what valuation.
The values for service-oriented businesses are based on a premise of multiples of cash flow or EBITDA. A rule of thumb for valuation of such a business is two to four times EBITDA.

Keep in mind that outside transactions (that is, not management-led) may generate a higher multiple on EBITDA for the seller. In a management buyout, the owner has to accept a lower price on the company than might be had in the open market.

That's also why a management buyout puts the current ownership in a box. As soon as management expresses their intent to purchase, and they can demonstrate they have the capital to afford it, the ability for the owner to sell at a higher multiple goes away, because no one wants to buy a company if the arrangement is not supported by management. To keep the proceedings amicable, it's important to demonstrate that you're offering the best possible price you can for the business based on the capital markets.

Question 5: Are you ready to act quickly? Being prepared to consummate the transaction before you go in to negotiate the deal is critical.
It may be advisable to have a third party negotiate the transaction with the owner on the management team's behalf. The primary advantage is that it allows management and ownership to maintain an amicable and positive relationship through the process. It puts the hard work on the shoulders of a third party. (In our case, this was not necessary, as the management team successfully negotiated directly with the owners.)

When you negotiate your terms, keep all assets in mind. Consider whether your business has established a brand reputation that's solid enough to continue operating under the same name. If so, make sure the current owners transfer to you the rights to certain marketing-related intellectual property, such as corporate logo designs. A third party may be able to help you decide what you should pursue and what you can use as negotiating leverage.

There is real appeal to being master of your own destiny. Management buyouts enable the management team to take control of the business and enable it to achieve its maximum potential.

If you can answer yes to the questions posed above, seize the opportunity. The key to your corporate growth is entirely in your hands.

David Baxa is President and CEO of VISTA Technology Services, Inc., a leader in facilities infrastructure analysis, IT and management consulting to support Defense Transformation and civilian agency efficiency requirements. David can be reached by email at david.baxa@vistatsi.com

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