What is a Buyout ?
Buyout is basically a transaction with respect to investment wherein the ownership of a company is acquired by another company either through stocks or equity ownership. This helps in growth of a company at a faster rate.
Targeting Company- The company whose shares are being bought
Acquiring Company- The company who is buying the majority shares in order to acquire.
In case of Buyout, the Target Company’s majority shares are bought by the Acquiring Company in order to have all the control.
e.g. Blackberry was acquired by Samsung through buyout for $7.5 Billion.
What is Leveraged Buyout (LBO) ?
A leveraged buyout is where one company acquires the other company using debts or borrowed money. This borrowed money can be in form of loans or bonds. The borrowed money is used in larger amounts than the equity. The ratio is often of 90% debt and 10% equity. The whole purpose behind the same is that companies can indulge into acquisitions without having to invest a lot of capital.
E.g. Blackberry can be acquired by Samsung through Leveraged Buyout. But how?
1. Either it can use its own funds, or
2. Borrow funds à LBO
In the case of Leveraged Buyout, the assets and the cash flow of the Target Company, i.e. Blackberry are kept as a collateral to the borrowed funds used to acquire the Target Company by the Acquiring Company. Hence the assets/cash flow are leveraged.
This is required as when the Acquiring Company goes to the banks to borrow funds, the banks would require a guarantee in case the Acquiring Company defaults. Here the assets/cash flows of the Target Company come into the picture and become the guarantee.
E.g. Samsung can use $2.5 Billion of its own funds and $ Billions of borrowed funds at some interest rate.
What is Management Buyout (MBO) ?
It is basically the acquisition of a business by its core management team which can be done in coordination with an external source such as a credited lender or a private equity firm. It is beneficial as the experience and knowledge of the existing members helps. In simple terms it could be understood as the purchase of a company by members of the management team itself.
This usually occurs when-
1. An owner wishes to retire
2. A parent company wishes to sell a part of their business.
E.g. There is a company ‘GLAD’ manufacturing toys for children and was formed 30 years ago. The founder of the company is now 70 years old and does not have the energy to handle the business on day to day basis. He has a management company who checks over the business to see that it is functioning smoothly. In order to retire from the business, the founder can go for a MBO.
Before doing the same he may consider the following things: -
1. Does the company has been functioning smoothly by the management team?
2. Is there a strong and viable team?
3. Should the owner retire giving out the business to management?
What are the Key Advantages of MBO?
- The owner can still have control over certain portions of the company.
- All the information about the company remains confidential.
- The risk is low and future is secured.
- It is easier for the management team acquiring the company to understand the business
- There is limited risk with higher returns.
Also read - Oppression and Mismanagement of Minority Shareholders
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