Buyout of a company – definition
Buying out a company involves taking over most or all of the company’s shares (a minimum of 50%) from its owners.
Investors decide to buyout for a variety of reasons. The most obvious is the desire to take control of a company and manage it according to their own plan. Some investors may use a buyout to strengthen their own position (expand their portfolio of owned companies) in the market or within a particular industry. It also happens that a buyout of a company is initiated by the owner or owners, who want to monetize the shares and use the proceeds for their own purposes (for example, when a family company lacks a successor to take over the management of the business).
A buyout is usually not a transaction in which an investor enters a company and buys out shares to increase capital, but this is not an absolute rule. Unambiguously assessing whether or not a buyout has actually taken place is often difficult.
The effect of a company buyout is that the buyer acquires the rights to manage the company and make key decisions about it – including a possible sale.
Buyout of a company – types
What type of buyout we are dealing with depends mainly on the entity(ies) that makes the purchase, but also on the way the transaction is financed. The most common distinction is:
- Employee buyout – employee buyout (EBO).
- Leveraged buyout – leveraged buyout (LBO),
- Management buyout – management buyout (MBO),
Leveraged buyout – leveraged buyout (LBO)
We can speak of a leveraged buyout when the bulk of the transaction was financed through debt financing (loans, credits, funds or external investors). Typically, the investor’s own contribution in a leveraged buyout is no more than 25%.
Important!
Other names for LBOs are credit-enhanced buyouts and leveraged buyouts.
In such a situation, the assets of the company involved in the transaction or the acquired shares (stocks) in it are often used as collateral.
LBOs are usually carried out with a view to restructuring and increasing the value of the company – with the aim, of course, of selling at a profit.
Investors who decide to carry out a credit buyout often choose companies whose financial situation is stable – they are not in debt and have steady revenues. The ideal candidate is a company with assets that can be used as collateral for a loan, and preferably undervalued by the market. Another thing investors look at is the company’s potential to cut costs through restructuring.
Leveraged buyout financing
A leveraged buyout involves an investment partner, the entity that finances the majority of the investment. Usually a bank or private equity fund plays this role.
Before deciding to provide financing, a partner will certainly verify the condition of the industry and the acquired company in its context, conduct or commission a financial analysis, and look at the company’s restructuring plan. All this is done in order to place his capital in a venture that is promising.
Management buyout – management buyout (MBO)
A management buyout is a situation in which a company’s managers buy out a majority stake or all of the shares of the company they manage. Management buyout can be carried out on its own (in a group of managers), but this is rarely the case. A buyout of a company, even a small one, usually consumes a lot of resources. The other most common solution is to carry out the buyout with the support of a partner – a financial investor (mezzanine funds, private equity, venture capital, business angels or banks often play this role).
In some situations, the financier of a management buyout may be the owner of the company. In this scenario, he may agree to spread the payment for the company’s shares into installments, and thus become the lender to the management team that wants to purchase the company.
Reasons for conducting MBO
Executives most often decide to conduct an MBO when the existing owner wants to withdraw from the business (for example, when he retires or wants to focus on another branch of his business). There are also times when the specter of a takeover by an outside company hangs over a business – in such a situation, managers may join forces to protect the company they manage from a hostile takeover.
Another important reason why an MBO may occur is the management’s fear of losing their job and source of income – for example, when the existing owner of the company doesn’t care who he sells it to and only cares about profit.
Consequences of a management buyout
When a company is transferred to the ownership of the people who have managed it until now, it usually involves a promise to secure existing jobs and preserve the company’s course. This is often a very important demand from the point of view of employees. The managers also take on more responsibility, becoming co-owners of the company. The result is often a significant increase in motivation and commitment.
As the people who run the company, are aware of its condition, know its internal processes, people and the problems plaguing it, taking control of the company can result in effective and needed changes that push the company on the right track.
A big advantage of a management buyout is the issue of reception from employees, but also from customers and business partners. Knowing that control of the company is now in the hands of people who were also responsible for it before (albeit to a lesser extent), these individuals are willing to give more credit to the company and to continue cooperation on previous terms.
Last, but not least, an MBO has the advantage of maintaining confidentiality in the context of the technologies used, finances, internal procedures, etc. With MBO, it is not necessary to share all sensitive information with external parties.
MBI – what is it and how does it differ from MBO?
Management buy-in (which is actually a management “buy-in”) is a situation in which a management team, previously associated with another company, decides to buy a stake (at least 50%) in a company. Although formally MBI works similarly to MBO, the perception of such an arrangement can be extremely different.
One of the characteristics (and strongly desirable) of MBOs is that the group of managers managing the acquired company knows very well its realities, employees, financial condition and so on. In the case of an MBI, this asset disappears – for control of the company is taken over by people who are strangers to it.
BIMBO – another variant of MBO
Under this sounding acronym is the term buy-in management buyout. BIMBO refers to a transaction in which a team of managers managing a company they want to acquire team up with outside managers. In this way, they share costs and, of course, shares.
BIMBO may be a remedy for the company’s current management team’s problems in obtaining financing for the company’s buyout.
Employee buyout – employee buyout (EBO)
This is the rarest, but not impossible, scenario. In an employee buyout, it is the employees of the company for sale who unite to buy a controlling stake in the company and take control of it.
In such situations, the leading motivation is most often to preserve jobs and working conditions, and to save the company from being taken over by outsiders. EBOs occur most often in small, family-owned companies.
Buyout of the company – other forms
In addition to those discussed above, there are other forms of company buyouts, which are usually a hybrid of two or more solutions. Among the best known are:
MEBO
Management & employee buyout – is a transaction involving both employees and managers of the company whose shares they are buying.
LMBO
Leveraged management buyout – a combination of a management buyout and a leveraged buyout, i.e. a transaction led by management but financially backed by outside parties.
There are two models for LMBO buyouts – Anglo-Saxon and French.
The Anglo-Saxon variant distinguishes three stages:
- First, the management of the acquired company raises capital and initiates contacts with potential investors. The first stage culminates in the establishment of a financial holding company to acquire the company.
- The next step is to raise capital to enable the acquisition of the company – including mainly raising external financing.
- Ultimately, a merger of the company and the newly formed holding company takes place.
In the French model, the process is similar. The difference lies in the rules adopted for the formation of the new company:
- managers and employees must hold at least 51% of the voting rights (an institutional investor cannot take more than 49%).
- The company is taken over by managers, employees and an investment partner (investor),
- Only people who have worked at the acquired company for at least a year can take part in the transaction,
Buyout of a company step by step
Although the buyout process will vary depending on the type of buyout selected, certain elements remain the same. Below are the steps that typically occur in a buyout transaction (or when preparing for one).
Choosing the right investment
In theory, this step applies only to external investors – private equity funds, venture capital funds, etc. However, it is equally important for individuals and entities that want to attract the support of these investors – how they present the offer to acquire shares in the company or the situation of the acquired company has a huge impact on the success of the venture (obtaining financing).
Within the framework of screening, the investor’s task is to recognize whether the offer presented to him is favorable. This is also the moment to make a preliminary analysis of the financial condition of the company subject to the buyout and to develop a business plan for the period between the acquisition of shares in the company and the completion of the investment (sale of shares). In the case where the investor plans only to make a loan, he creates assumptions about the expected return on investment.
Company valuation
A stage that cannot be skipped is the valuation of the company. It determines what amount for the sale the seller can expect. The valuation is influenced by a number of factors, such as the company ‘ s current financial situation, transaction history, potential for growth, the company’s assets, its liabilities and debts – in a word: all the elements that concern its finances.
There are many methods for valuing a company, including the simple accounting method, but also more complicated and insightful methods: discounted cash flow DCF or adjusted present value.
Negotiations
With a valuation and capital (or the promise of capital) in hand, investors, employees and managers can enter negotiations for a buyout.
The parties to the negotiations will be different individuals and entities – depending on the type of buyout:
In the case of a leveraged buyout, a representative of the fund or other entity financing the transaction will take part in the negotiations, as well as the owner of the company that is the subject of the buyout.
In the context of a management buyout, negotiations will take place between the management and the owner of the company. If external financing is used as part of the MBO, the investor’s representative should also take part in the talks.
In an employee buyout situation, discussions should take place in the presence of the company’s owner, management, employees and a representative of the investor. The subject of negotiations may be the distribution of shares and the creation of an ESOP (employee stock option plan).
Due diligence (due diligence)
Under this term is a detailed and in-depth study of the situation of a company. Due diligence is usually commissioned by an investor who plans to buy (acquire) a company. Based on the due diligence report, he decides whether the offer presented to him will bring him the expected benefits.
Comprehensive due diligence examines a company’s financial condition as well as its legal and tax situation, business relationships or technological background.
Finalizing the buyout
At this stage, the parties agree on the final details, financing terms, sign contracts and guarantees.
Funding
Once the parties involved in a buyout deal have entered into an agreement, the financing stage begins. It is at this point that loans are made and funds are disbursed to the sellers.
Closing the deal
The final stage of the buyout is when the parties meet the pre-established closing conditions. Among them may be: executed and confirmed payments, signing of required documents and settlement of legal issues. At this stage, the transfer of shares also takes place – in accordance with the terms agreed upon at the previous stages of the transaction.
Summary
A buyout of a company can take place internally (MBO, EBO) or externally (LBO), but external parties are involved in the transaction in most cases, even when there is a management or employee buyout.
The funds that finance a buyout can come from loans, credits, contributions from funds, and the sale of company assets. The purpose of a buyout, on the other hand, can be to preserve jobs and the company’s character (for employees), to take more control, to increase earnings (for managers), and to maximize profits or expand the portfolio of companies owned (for outside investors).
