Existing Management Wants to Buy-In New Company, How to Incentivize Mgmt
April 12, 2023
by a searcher from Duke University in Tulsa, OK, USA
I have come across a good opportunity to buy a successful company. The owner has been very successful and wants to sell since he is 75. The current general manager would like to buy the company but doesn't have enough money to do so.
The owner would like his general manager to buy into the new company so that he has a portion of the equity after the transaction. This concerns me for a few different reasons but the largest is the fact I don't know the GM so becoming equity partners while I have a personal guarantee on a loan is something I am not interested in.
What would be a good way to address this? How do PE firms traditionally incentivize the existing management after an acquisition?
Carried interest is used in a traditional search but I believe part of that is rewarding the searcher for finding and closing the new business and bringing it to the investors. Whereas existing management incentives may not be as lucrative.
My thoughts lean toward proposing to buy 100% of the business and offer the current GM a very large bonus in 5 years if he operates it successfully such that he could use that as downpayment to buy me out.
Opinions on this?
from Indiana University at Bloomington in Chicago, IL, USA
A lot of great advice here so far, so I'll take a different approach from the crowd.
I don't know the size of the transaction, but if it's smaller and you plan to scale it significantly, be thoughtful of the adage "There's horses for different courses". The GM might seem great now, but this is when asymmetric info is at it's highest. Food for thought, but this GM might only have a 12 month shelf life and slow progress with possibly their staid mindset.
So I'd personally side on implementing the least complex deal structure so as not to hamper transaction momentum. Also, try to defer true incentive structuring until 12 months post acquisition. For example, year one profit share on two metrics that you want your 'new' GM to obsess over (I prescribe the Girdley framework - link below).
You'll know before the first year rolls around how aggressive / cost creative you'll need to be after seeing their work.
That's what we did, and we had an eerily similar situation to what you described. We provided a milestone cash bonus for the first year. It was a sweet deal for this person, but then again we felt like we needed them the most during the first year and could reassess in year 2. We reduced our salaries to help finance this additional cost in year one, plus the seller kicked in half the bonus money. GM felt respected because all parties contributed.
Hopefully you can speak to the GM and hear what their preferences are (e.g. ego stroke, security, upside, etc). You might be surprised on what they're looking for. Our GM ended up realizing that they were better off being an employee than a small minority owner. I'd be very cautious on offering equity or rights.
Happy to share our outcome if you want. Just PM me.
Good luck!
https://girdley.com/my-ceo-compensation-framework/
from The University of Chicago in Chicago, IL, USA
2) The GM's interest is a great thing. But it could be a bad (very) thing if he is not incentivized by the new owner.
3) (Assuming your equity is low), once the seller understands your capital stack, there is some risk that he/she may fund GM's equity. I know of one such situation. At the end the deal did not happen for seller b/c GM's wife did not like the PG
4) You have to buy 100% of the business (not necessarily 100% of equity) and then find a way to bring in GM with incentives. Many suggestions have been made above; I would recommend stay with proven, easy-to understand and less-subject-to-misunderstanding approach. Avoid having to measure value. That is for public companies or ESOP.
In the PE world managers and PE have the same capital stack layer and managers get x% (sometimes called management pool) on waterfall. There are exit options for early exit. I structured one recently where the owner was not selling but wanted to give % ownership to key mangers to accelerate growth.
Few examples of PE:
PE's equity was $3 million. Preferred and Sr. were above that. PE then modified their equity into $2.9 M (let me call that piece of the stack a junior preferred) and $100 k common. Manager bought into the common, say $10 k (Y) for 10% of common. Common would have value after Sr., after Preferred and after junior preferred. In another case, a much larger deal, the PE even loaned the CEO the $Y to buy common. Often the CEO gets not only the $Y but high###-###-#### %) of common.