Once, baby boomers could not have been blamed for thinking that when it came time to pass on their life’s labours to the next generation, any number of potential purchasers would be waiting, allowing them to retire with their nest eggs. Circumstances have put paid to that. The global economic collapse, the tightening of available credit, the failure of lending institutions and a cooling down of risk appetite mean the windfall just isn’t there.
Nor is the talent. The demand for leaders—particularly those with the skill set to buy and build a business—greatly exceeds supply.
So the hunt for successors is now occurring within businesses. Companies need to build leaders who will become an integral part of the business, and who are great candidates to lead management buy outs or other forms of succession development.
Here is where grooming has come into its own.
The 'Heir Unapparent'
Bringing in an outsider for the top job poses risks. Academic Ann Klein explains: "If you go outside, there's a huge learning curve to understanding a company's strategy and culture. Somebody new coming in from the outside is very dependent on those left in the company for orientation, perspective and information. That's potentially problematic."
“What you would like in an ideal scenario is careful succession planning that grooms people internally. One reason is you want to maintain the intellectual capital of the organisation. Another is that you want to motivate people in the upper levels of the company to stay and excel because they might get to lead the company someday...or even buy it.” Hence the phenomenon of grooming from within.
Hayes Knight’s Business Improvement Team say that management buy-outs are a tried and true method of maintaining business momentum and a bona fide succession model. It’s important, though, to dedicate a mix of resources to ensure those managers buying ‘in’ fit the bill. Generational Succession Planning can also include elements of ‘grooming’ but with blood being thicker than water, a commitment to cherish and grow the operation probably already exists.
James Phillips, Head of Key Segments for ASB’s Commercial Banking, says MBOs have traditionally featured certain funding and structure characteristics.
“They use large amounts of debt and as a consequence the business becomes highly geared, making the capital structure involved very important. They therefore tend to favour certain types of businesses—those with large amounts of cash, as the worry is that leverage ratios can be driven beyond prudent levels. High gearing does tend to encourage cash flow management. Subsequent to the buy-out, management tend to look at cost reduction activities as opposed to revenue generating strategies. So that can alter the complexion of a particular operation.”
Structuring aside, James says ensuring that people have a vested interest in the success of a venture—over and above it simply being a job—further helps to galvanize commitment.
“When someone has a stake in the game, it tends to steady their hand on the tiller.”
Hayes Knight concur, stating “We’ve found that managers and senior people that then become owners of an operation tend to be harder working and more vigilant. They often are more innovative and can better implement cost cutting strategies over revenue enhancement initiatives. They have a more critical eye on deferring acquisition and capital expenditure until exposure and leverage are reduced. They’re more mindful following related versus unrelated diversification and they tend to be more proactive and ‘timely’ in making strategic decisions mainly because, as shareholders, they’re less likely to let bureaucracy impede taking affirmative action.”
Determining candidates for grooming can be done in two ways. Either they’re appropriately qualified to take over as owner of the business, or they are financially able to fund a purchase.
With the latter, says James, it may require that the business be sold to a team who between them have the knowledge to operate it, and the funds to pay for it. Funding can be through cash, some sort of leveraged buy-out or even the creation of types of share plans.
The nature of a management buy-out is such that often the vendors and purchasers are going to work in tandem for a period of time albeit with different ‘positions’.
Hayes Knight advises that all involved should have agreed on the end objective. During the transition period there will be a period of cooperative management and operation. This is necessary to maximise the outcome for all of the participants.