Leveraged Buyout: A Mandatory Provision For Growth and Security
May 9, 2023 •Oak Street Funding
We all like to think that we’ll know when it’s time for us to walk away from work for good. In fact, many of us are so eager for the things we’ll be able to do when we retire that we look forward to it. Some obligatory lunches with longtime colleagues, transition meetings with favorite clients, an after-work reception and a leveraged buyout … and then we’ll put it all behind us.
But what do you do when someone is clearly ready for retirement and won’t go? What do you do with a longtime partner who is dragging your practice down and isn’t picking up on the hints that it’s time to go fishing or play golf? How do you handle a partner who sees himself or herself as integral to the practice’s viability when they are really keeping it from becoming what the clients and fellow partners need to it be?
What is a leveraged buyout?
This is why it pays to have a mandatory leveraged buyout provision in your partnership agreement. Such a provision spells out specific reasons that a CPA practice’s partners may use to show another partner the door. Such provisions might include a mandatory retirement age, significant reductions in profitability, mistakes that put the practice in a position to lose clients, a failure to maintain licensing or continuing education requirements, legal or ethical lapses, or significant health matters such as early signs of dementia.
Who benefits from a leveraged buyout?
A mandatory leveraged buyout offers the remaining partners a graceful way to ease a partner who’s no longer pulling his or her weight out the door. If the provision is well-drafted, it takes much of the emotion out of the process, allowing the remaining partners to point to business conditions that all of the partners have agreed to observe. If your practice is interested in adding a mandatory leveraged buyout provision to your partnership agreement, you’d be wise to consult with experts who have designed similar provisions for other practices.
We have to recognize that retirement isn’t always a partner’s goal, particularly if that partner has few outside interests or motivations. It may be that work is critical to his or her sense of self-worth, or that the partner’s ego struggles with the idea of younger partners taking over clients with whom she’s had a strong personal relationship. In those cases, forcing retirement in the absence of a mandatory leveraged buyout provision can create resentment, leading the departing partner to damage relationships with clients and hurt the practice’s future earnings.
Not a Merger & Acquisition
A leveraged buyout differs from a merger or acquisition because in a leveraged buyout, the remaining company and partners simply acquire more equity in the existing company. This can be attractive to aging owners because it provides a way to exit the company without having to sell the entire company or find a buyer for all of its assets.
On the other hand, mergers and acquisitions refer to the consolidation of two or more companies into a single entity. Mergers and acquisitions can be structured as a merger or an acquisition, depending on the relative size and power of the companies involved.
Who Takes on the Debt?
In a leveraged buyout, the debt is typically taken on by the target company being acquired. The firm that is financing the leveraged buyout provides the capital for the transaction through a combination of debt and equity, with the majority of the financing being debt. This debt is used to purchase the ownership stake in the target company, and is typically secured by the assets of the target company.
As a result, the target company becomes highly leveraged, with a significant portion of its assets tied up in debt. The hope is that the target company's future earnings and cash flow will be sufficient to service the debt and generate a return for the target company and its investors. However, if the target company's financial performance does not meet expectations, the debt burden can become a significant risk to its stability and future success.
A Mandatory Leveraged Buyout Provision is a Long-Term Plan
Drafting and implementing such provisions long before any of the current partners consider stepping down is critical to avoid future angst. If retirement appears to be a far-off dream, professionals will be more likely to agree to provisions that may not affect them for many years. Trying to force a new leveraged buyout provision on a partner close to retirement age may be taken as a personal attack.
In addition to spelling out the rationale for triggering a leveraged buyout, the provision must also address how the practice will finance the move. It’s critical that buyouts be self-funding, or they will decrease the value of the remaining partners’ ownership. One strategy is to use third-party financing to spread the cost of the buyout over several years. Specialty lenders, like Oak Street Funding®, understand the CPA practice model and can lend based on income, rather than assets.
Oak Street Funding has supported hundreds of customers for leveraged buyouts, and we can help you. Contact us to learn more.
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.