Turning Managers Into Owners:
Reducing the Risk of Failure in Employee Buy-Outs
By Paul R. Brown, M.A.
Here’s one of the “dirty little secrets” of selling a business: In most cases the owner will not be able to find a buyer. And, since the value
of the business is usually the largest single asset in his or her personal wealth the post-transition lifestyle can suffer. To say the least.
Because of the lack of buyers more and more owners are approaching their transition like Richard (not his real name). He owns a
successful professional service firm with a national reputation and few hard assets. After discussing different transition scenarios –
including strategic buyers, investment buyers and family succession – he decided that his best option was to put together an employee
buy-out whereby key managers would be given an opportunity to own what they helped grow.
As a part of the transition process I performed a series of group and individual interviews. We needed to determine the interest,
willingness and capabilities of the buying group. In this case the managers were excited about the possibility of ownership and were
willing to make an initial financial investment to further show their commitment. So far so good.
Richard agreed to finance the sale over a five year buy-out. It was at this point the entire plan nearly came to an abrupt halt. He realized
that none of his managers, though capable in their current role, had the requisite skills needed by an owner to keep his large business
growing. If they failed he would have to come back and re-start the succession process. For Richard, the risk was too great.
There are a number of reasons a business can fail after transitioning to new owners including outside buyers, key employees or family
successors. However, in most cases the primary factor can be found in four key areas: General Business, Financial, Marketing or
Human Resources. A management succession process that provides training and experience in each of these critical fields can greatly
increase the likelihood of transition success. Something everyone wants to see happen.
In the following sections each of the factors listed above will be explored. Taken together they provide a minimal guideline from which
potential owners can be assessed early in the transition planning process.
General Business Factors Contributing to Business Failure
Why businesses fail: New owners attributed the failure of the business to the following General Business Factors:
1. The lack of a well-developed business plan, including insufficient research on the business, its market and its competition (78%)
2. Being overly optimistic about achievable sales, money required and what it takes to be successful (73%_
3. Not recognizing or ignoring what they don’t do well and not seeking help from those who do (70%)
4. Insufficient relevant and applicable business experience (63%)
Every business decision an owner makes carries an element of risk. Successful owners minimize the risk by grounding their decisions
in reality. Over time they have learned that their “gut feeling” may in fact have more to do with last night’s pizza than today’s business
challenge.
In an effort to prove themselves, new owners frequently attempt to accomplish too much, too soon. Their energy, though welcomed, can
actually keep them from studying the strategic issues that will lead to sound decisions including such mundane items as budgetary
constraints, personal capabilities and market realities.
Before agreeing to sell the business to an employee or a group of employees, owners must be confident in their ability to ground their
decisions on the firm foundation of “what is.” Lacking that confidence, the owner should either provide successors with an opportunity to
develop their decision making skills or concentrate on finding an outside buyer.
Financial Factors Contributing to Business Failure
Why businesses fail: New owners attributed the failure of the business to the following Financial Factors:
1. Poor cash flow management skills (82%)
2. Too little money (79%)
3. Poor pricing strategies (77%)
A few years ago a friend of mine sold his successful hydroponics operation. He had become the largest wholesaler of sprouts in the
region, having built his company through the familiar combination of hard work, good fortune, customer care and determination. Prior to
the sale he started to grow weary of the constant challenge of selling to wholesale accounts. Though his receivables were high, the
available cash was not.
If they are not careful, new owners can burn through a lot of money in a short period of time. The old computer systems need upgrading.
The stores need remodeling. The inventory needs replenishing. Before long cash – which is “king” – has been removed from its throne
and the business is one set-back away from going under.
When reviewing the capabilities of internal successors, owners must take a hard look at their proven experience in managing budgets
and cash flow. Lacking this, it will only be a matter of time before the business experiences a cash crunch that can put the entire
operation at risk.
Marketing Factors Contributing to Business Failures
Why businesses fail: New owners attributed the failure of the business to the following Marketing Factors:
1. Minimizing the importance of promoting the business properly (64%)
2. Not understanding or ignoring the competition (55%)
3. Too much focus or reliance on a single customer (47%)
I was performing a due diligence on a business after a client asked me to assist him with the sale of his company. The previous three
years had been profitable. The debt had been drawn down without sacrificing strategic improvements. He had some key employees
willing to stay with the new owners. In his mind, he was sitting on a goldmine that could be sold for a premium. This is what he knew.
What he didn’t know was that his largest customer (who represented more than 50% of the company’s business) was actively looking
for another supplier. Without our due diligence he would have lost his customer and in the process his business.
Most managers succeed without ever having to market the business and its products or services to others. If they are client managers
they may have built their careers around a carefully maintained relationship with one or two primary customers. They are good
managers, but are not capable of becoming good owners with a limited marketing focus.
Human Resource Factors Contributing to Business Failure
Why businesses fail: New owners attributed the failure of the business to the following Human Resource Factors:
1. Inability to delegate properly (micro-managing) or over delegating and abdicating key management responsibilities (58%)
2. Hiring the wrong people and not people with complimentary skills, or hiring friends or relatives (56%)
The late Peter Drucker wrote, “The ability to make good decisions regarding people represents one of the last reliable sources of
competitive advantage, since very few organizations are very good at it.” At the very least then, failing in the area of human resources will
keep the company from gaining any advantage over its competition. Unfortunately it can also bring a business down. Micro-
management, abdication and poor hiring will quickly undermine years of business success.
Frequently managers are not given an opportunity to hire subordinates. Or if they are, they are not held accountable for the results. In his
book, Top Grading, Bradford Smart makes a convincing case that by and large leaders do a poor job of hiring. He believes that a
company will only hire the best available person for the job in 3 out of 10 attempts. The remaining 70% represent a costly mistake for the
business.
Until managers prove their ability to hire and retain a strong team of employees they are not ready to become owners.
With a limited number willing to invest in middle-market companies, creating internal buyers for the business or practice should be
considered if, and that is a huge qualifier, the owner is capable of turning his or her managers or successors into owners. With proven
experience in the areas of general business, financial management, marketing and human resources the new owners have a good
chance of succeeding.
Without that same experience, however, they have an even better chance of failing.
Written by Paul R. Brown. All rights reserved.
© 2005 to present Paul R. Brown