CFO cum Business Advisory

All You Need To Know About Leveraged Buyout Or LBO To Success In Business Takeovers (Part 2 of 3)

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( continued…)

Part 2 of 3 : Elaborating the 3 common types of LBOs

 

MBO 

1. A special case of a leveraged acquisition is a management buyout (MBO).

2. In an MBO, the incumbent management team (that usually has no or close to no shares in the company) acquires a sizeable portion of the shares of the company.

3. An MBO can occur for a number of reasons; e.g.,

* The owners of the business want to retire and want to sell the company to the management team they trust (and with whom they have worked for years)

* The owners of the business have lost faith in the business and are willing to sell it to the management (who believes in the future of the business) in order to get some value for the business

* The managers see a value in the business that the current owners do not see and do not want to pursue

4. In most situations, the management team does not have enough money to fund the equity needed for the acquisition (to be combined with bank debt to constitute the purchase price) so that management teams work together with financial sponsors to part-finance the acquisition.

5. For the management team, the negotiation of the deal with the financial sponsor (i.e., who gets how many shares of the company) is a key value creation lever.

6. Financial sponsors are often sympathetic to MBOs as in these cases they are assured that management believes in the future of the company and has an interest in value creation (as opposed to being solely employed by the company).

7. There are no clear guidelines as to how big a share the management team must own after the acquisition in order to qualify as an MBO, as opposed to a normal leveraged buy-out in which the management invests together with the financial sponsor.

8. However, in the usual use of the term, an MBO is a situation in which the management team initiates and actively pushes the acquisition.

 

MBI

Similar to an MBO is an MBI (Management Buy In) in which an external management team acquires the shares.

 

Secondary Buyout

1. A secondary buyout is a form of leveraged buyout where both the buyer & the seller are private equity firms or financial sponsors (i.e., a leveraged buyout of a company that was acquired through a leveraged buyout).

2. A secondary buyout will often provide a clean break for the selling private equity firms and its limited partner investors.

3. Historically, given that secondary buyouts were perceived as distressed sales by both seller and buyer, limited partner investors considered them unattractive and largely avoided them.

4. Often, selling private equity firms pursue a secondary buyout for a number of reasons:

* Sales to strategic buyers and IPOs may not be possible for niche or undersized businesses.

* Secondary buyouts may generate liquidity more quickly than other routes (i.e., IPOs).

* Some kinds of businesses – e.g., those with relatively slow growth but which generate high cash flows – may be more appealing to private equity firms than they are to public stock investors or other corporations.

5. Often, secondary buyouts have been successful if the investment has reached an age where it is necessary or desirable to sell rather than hold the investment further or where the investment had already generated significant value for the selling firm.

( look out for LBO Part 3 of 3 )

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Written by Kelvin Loh