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Small Business | Financing and Insurance

When It Comes to a Management Buyout, Investors Are on Your Side

April 29, 1998|JUAN HOVEY

Picture this:

* You work as a senior manager for a thriving family-owned widget-manufacturing business founded 25 years ago.

* Your bosses, a husband-and-wife team, have no children waiting in the wings to take over, and they don't want to make widgets anymore. They want to play golf in Hawaii--full time.

* You and a handful of other senior managers run the business, by and large, and would love to own it, too.

* You aren't exactly flush with cash.

What to do?

Think "management buyout"--and remember that when investors look for opportunity among small- and middle-market businesses, they care far less about product or service than they do about good management. This means that if you lead a good management team and you can scratch together a little money of your own, you stand a good chance of finding investors to back you in taking control of the business you manage.

It takes some doing to put a management buyout deal together, and you can't do a deal with no money down, as it were; private investors don't back managers who have no resources of their own to put into a deal.

But a management buyout isn't a complicated deal, and your hardest job isn't finding investors. It's proving that you and your management team can grow the business fast enough to give investors a good return--and yourselves a good chance to become 100% owners.

Southern California is host to many businesses prime for management buyouts--companies whose founders want to retire. Investors know this.

"In Southern California, there is a particularly high concentration of solid small- to mid-sized businesses that were never publicly owned and never will be," says Matthew Witte, a partner in Marwit Capital, a Newport Beach investment firm that backs management buyouts involving small- and middle-market businesses. The firm also invests in companies undertaking growth or acquisition campaigns.

"Some of the founders of these businesses have children who can take over, but a lot don't," Witte says. "We see a huge generational shift coming among these businesses as the people who founded them in the 1960s and '70s transfer them to the next generation.

"We think there's a very large opportunity for investors like us to finance these generational transfers. We're in business to provide the capital people need to carry these transfers out."

In the last two years, Witte and partners Chris Britt and Jeffrey Schaffer have invested $24 million in 15 middle-market businesses, most on the West Coast, usually in chunks of $1 million to $5 million at a time. They marshaled $45 million in bank financing to cement the deals and to ensure that the companies would thrive.

Half of their deals were buyouts involving management teams long on experience and short on capital.

A recent Dun & Bradstreet survey counted 27,000 businesses in California with revenues ranging from $5 million to $50 million. Since two-thirds of the state's population lives in Southern California, the partners figure that two-thirds of these small- and middle-market businesses operate here too, many of them run by management teams itching to become owners.

Many of these managers already know that bankers don't finance buyout deals. What the managers don't know is that private investors stand ready to help a company's managers become its owners even if they can raise only a fraction of the capital they need to do the deal themselves. These investors want first and foremost to see good management in place.

Witte says a typical Marwit Capital buyout involves a company doing $25 million in sales under a senior management team of two to four people who, among them, can come up with $250,000 to $500,000, perhaps by mortgaging their homes or cashing in investments.

If the company earns, say, 10% before taxes, it might sell for four times earnings, or $10 million. The management team puts up $500,000, and Marwit arranges $6.5 million in senior bank financing. It adds $3 million of its own to the kitty in a classic mezzanine financing deal, previously described in this column.

Technically, the bank secures its $6.5 million with such company assets as equipment, real estate, inventory, receivables. Marwit Capital puts up some of its money as unsecured subordinated debt and some as equity capital. Simply, Marwit Capital lends the management team some of the $3 million, and it uses the rest to buy a minority position in the company stock--usually not more than 35% to 40%. Some debt-heavy deals give Marwit Capital the right to buy stock, only later on.

The bank debt amortizes over three to five years at market rates. The subordinated debt from Marwit Capital earns interest at 11.5% to 12.5%. Most often this layer amortizes over five to seven years; sometimes it earns interest only, with a balloon payment due five to seven years down the road. Marwit Capital expects a total return exceeding 25% per year.

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