As the private equity world has expanded in the past 15 years, management-led buyouts have become an increasingly common source of deal activity. For example, according to Berkshire Capital LLC, there were 44 management buyouts in the investment-management industry between 2003 and 2005, as many as in the preceding nine-year period.
In spite of this increase, management-led buyouts are generally chaotic and often seem on the verge of capsizing all the way to closing. From an intermediary’s point of view, whether an adviser is retained by selling shareholders or by management, the other party often seems to be the one in control.
There are indicators, however, that make the successful completion of a management-led buyout more likely rather than less. Experience suggests that when all or most of these factors are present, the principals can choose a transactional approach that significantly increases the chances of success.
One recently completed transaction demonstrates this approach.
Background
Senior Care Centers of America Inc. is an operator of adult day care facilities headquartered in Trevose, Pa. Senior Care operates 20 centers in five states.
In Dec. 2005, Clearview Capital, an Old Greenwich, Conn.-based private equity fund focusing on companies with $3 million to $20 million of EBITDA, acquired control of Senior Care in a management-led buyout.
The controlling shareholder, pre-transaction, was an entrepreneur who nurtured Senior Care’s growth, but was not involved in day-to-day management. Jim Donnelly and Craig Mehnert, Senior Care’s CEO and CFO, rolled over their equity and continue to manage the business.
Our firm had discussed a private equity-backed leveraged transaction with management early in 2004. At that time, the company was exploring another transaction and the managers begged off. By fall, that deal had stalled, and Donnelly, the CEO, asked us to pick up the discussion, this time with the owner.
The transaction that then appeared achievable-a management buyout that would meet the selling shareholders’ financial expectations and leave the two key managers with a substantial equity position-was sufficiently interesting to both sides. We were retained by the company to pursue a transaction on behalf of both the owner and management.
Four Success Indicators
Even when owners and managers begin with a good relationship, the nature of a management-led buyout causes their interests to diverge. Management’s bid may or may not meet the sellers’ expectations, or even be the best offer. The buyer offering top dollar may or may not be the one that offers management the most lucrative economics or the best situation post-transaction.
The resulting tug-of-war can strain even the best preexisting relationship. However, our experience suggests four factors that increase the likelihood of a transaction that will satisfy the objectives of both ownership and management.
1.Management has established a clear record of success.
2.Management holds some equity position pre-transaction.
3.Ownership’s valuation expectations reflect prior exposure to the marketplace.
4.The buyer universe is uniform in terms of need for incumbent management.
Senior Care Centers: An Excellent MBO Candidate
Senior Care Centers is a well-regarded industry competitor that turned out to be an excellent candidate for a management-led buyout, in large part because of the presence of these factors.
Factor #1: Management Track Record.
In the several years prior to a transaction, Senior Care Centers had achieved consistent revenue growth, margin expansion and improvement in performance at the individual facility level. By early 2005, the age and composition of the centers in operation suggested that the system as a whole was positioned for continued growth. In addition, management had successfully completed several smaller acquisitions.
Management was therefore able to avoid two familiar pitfalls. Private equity investors tend to grow wary of management teams when: (a) their achievements pre-sale are not easily separable from the efforts of exiting shareholders or (b) their investment proposition is based on improving uneven performance once they are free of constraints said to be imposed by the sellers.
In this case, Donnelly and Mehnert were able to strike the right balance. With the owner’s support, they had proven their ability to drive organic growth and to integrate acquired locations. When management depicted the business as ready to shift into overdrive with institutional rather than individual ownership, the company’s historic performance reinforced their credibility.
“Management buyouts like this one are especially interesting since the people most knowledgeable about the company’s operations, and its value, are also willing buyers,” said James Andersen, co-managing partner of Clearview Capital. “We felt Jim and Craig were the right team to capitalize on this business platform.”
Factor #2: Management Equity Position.
Senior Care’s Owner had enabled Donnelly and Mehnert to accumulate a small equity position in recognition of the Company’s steadily improving performance.
This had two positive effects on this transaction, as it does generally.
First, it’s a question of math-ownership pre-sale reduces the amount of capital management needs to raise. Second, the greater management’s equity position, the more they are motivated by ownership as opposed to compensation and bonuses. This more firmly aligned Donnelly and Mehnert with their equity partner, at least from an economic standpoint.
Factor #3: Prior Market Exposure.
While Senior Care’s principals had never offered the business for sale, they had been approached with prospective transactions. In some cases, counterparties had expressed their view of Senior Care’s value. This gave the owner and managers first-hand data to consider along with the standard abstracted reference points-prepared valuations, comparable public company valuations and publicly reported M&A data.
While the two sides naturally approached a prospective buyout with a gap in valuation expectations, the differential clearly was less as a result of the prior market experience.
Factor #4: Uniform Need For Management.
It’s difficult for management and selling shareholders to commit to a cooperative marketing process when their view of individual buyers is destined to diverge. Nothing causes divergence faster than strategic acquirers-or financial buyers already committed to a management team-who appear attractive to the sellers but problematic for managers aspiring to operate the company post-transaction.
In this case, for a variety of reasons the parties focused on financial acquirers with no prior involvement in the adult day care industry. As a result, the relationship between the buyer universe and management was generally equalized. Each prospective buyer had a similar need for Donnelly and Mehnert and a similar inclination to involve them as owners.
The Process.
Each of these factors removes or at least significantly reduces a common cause of division between selling shareholders and management. The presence of all four in this case led the principals to conclude that their respective objectives could be achieved in a unified process managed by one investment banking firm, rather than through arms-length negotiation involving multiple advisers.
The sale process here was highly competitive, yet bidders had limited opportunities to win or lose based on their expressions of business value.
We sought indications of interest within the valuation range the owner and management had previously expressed. Based on discussions with lenders, we gave bidders our own sense of available leverage, which reinforced the valuation guidance.
Management conducted a series of successful management meetings. Three firms were invited to prepare final bids, but in the absence of more specific guidance, how would you bid-high to win over the selling shareholders, or low to get the support of the continuing managers?
The owner, Donnelly and Mehnert, their respective lawyers, the company’s counsel stepped away from the buyers and developed an intra-seller agreement, which, among other things, set an enterprise value for the equity groups to meet.
The principals were exposed to a single financial model. The low asking price was less than buyers were prepared to pay. The high price resulted in a transaction that was probably financeable but left the business with a thin cash cushion in year one. The parties settled on an intermediate valuation that was acceptable to all of the final bidders.
With purchase price stipulated, the private equity groups were left to compete on management’s economic package, on relevant industry experience and on personal chemistry.
“Our decision to partner with Clearview was based on the experience, style, and personalities of the principals, and on how management was valued in the process,” Donnelly said. “We concluded that their management approach would mesh with ours, and that this was the group best positioned to support our efforts to achieve superior financial returns.”
This process did not avoid other issues that were vigorously contested by the parties. It did enable them to agree on a course of action and then on major deal terms in a generally non-adversarial manner.
Where possible, this collaborative approach has benefits for the parties to a management-led buyout, as well as for prospective investors and lenders assessing its chances of reaching the closing table. v
Andrew Greenberg and Daniel Ferry are managing directors of Greenberg Ferry LLC, an M&A advisory firm based in Bala Cynwyd, Pa.
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