Buyout Meaning

Usually, buyout takes place when a purchaser acquires more than 50% stake in the target company resulting in a change of management control. If the company’s management acquires the stake, it is known as a management buyoutManagement BuyoutA management buyout (MBO) is a type of acquisition where the management of the company acquires the ownership of the business by increasing their equity stake or by purchasing assets and liabilities with the objective of leveraging their expertise to grow the company and drive it forward using own resources.read more (MBO). On the other hand, if the acquisition is funded through a significant level of debt, then it is known as a leveraged buyoutLeveraged BuyoutLBO (Leveraged Buyout) analysis helps in determining the maximum value that a financial buyer could pay for the target company and the amount of debt that needs to be raised along with financial considerations like the present and future free cash flows of the target company, equity investors required hurdle rates and interest rates, financing structure and banking agreements that lenders require.read more (LBO). Usually, companies opting to be private go for buyouts.

Buyout Process

The process is initiated by the interested acquirer who makes a formal buyout offer to the target company’s management. It is then followed by rounds of negotiations between the acquirer and the management of the target company. The management shares their insights with the shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more and advise them on whether or not to sell their shares.

Wealthy private individuals usually provide the funding used in transactions, private equity investors, companies, pension funds, and other financial institutions. In some cases, the target company’s management is not very willing to go ahead with the acquisitionAcquisitionAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more, and such buyouts are considered hostile takeoversHostile TakeoversA hostile takeover is a process where a company acquires another company against the will of its management.read more, while, the rest is seen to be friendly takeoversFriendly TakeoversA friendly takeover occurs when the target company peacefully accepts the acquisition offer. The takeover is subject to the approval of the target company’s shareholders as well as regulatory approval to ensure that the acquisition complies with antitrust laws.read more.

Types of Buyout

There are two major types – Management and Leveraged buyout.

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  • Management: Here, the company’s existing management gains control of the company from its owners through the purchase of management control. The management finds the potential of the company to be attractive and hence intends to earn higher returns by becoming owners instead of employees of the company.Leveraged: In this type, a significant portion of the acquisition is backed by debt. As the acquirer gains control of the target company, its assets are often used as collateral for the debt. In this way, the purchasers can acquire companies that are quite large as compared to their funding ability.

Examples of Buyout

Example #1

In the year 2013, Michael Dell got involved in one of the nastiest Tech buyouts. The founder of Dell joined hands with a private equity firm, Silver Lake Partners, and paid $25 billion to buy out the company he had originally founded. In this way, Michael Dell took it privately to have better control over the company operations. It is a classic example of a management buyout.

Example #2

In the year 2007, Blackstone Group acquired Hilton Hotels in a $26 billion LBO deal. The deal meant that each shareholder got a 40% premium over the prevailing share price. The acquisition was largely backed by debt funding of $20.5 billion, while the remaining was equity by Blackstone. Some of the banks in the consortium lending included Bank of America, Lehman Brothers, Goldman Sachs and Morgan Stanley.

Advantages

  • These buyouts help eliminate product or service duplication that can significantly reduce the operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more and in turn, increase the profitabilityProfitabilityProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more.The purchaser can enjoy the benefits of economies of scaleEconomies Of ScaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. read more acquiring the competitors.The companies can increase their profits by buying their competitors, eliminating the need for competitive pricing.In some cases, both the acquirer and the target company mutually benefit through sharing each other’s resources.

Disadvantages

  • In most cases, the buyouts are backed by a large amount of debt that affects the capital structureCapital StructureCapital Structure is the composition of company’s sources of funds, which is a mix of owner’s capital (equity) and loan (debt) from outsiders and is used to finance its overall operations and investment activities.read more of the acquiring company. It results in higher leverage and increased obligation in the acquirer’s books. In some cases, the target company’s management is not in favor of the buyout, and hence they quit. So, it is no surprise that many of these acquisitions are followed by the resignation of some of the key personnel of the target company. It sometimes becomes a great challenge for the acquirer to find a replacement.Although both acquirer and target company may belong to similar businesses, the corporate cultures and operating methods can still be significantly different. It may lead to resistance to change within the target company, which may result in costly problems.

This has been a guide to buyout and its meaning. Here we discuss processes, examples, and top 2 types and advantages and disadvantages. You may learn more about financing from the following articles –

  • Best LBO BooksTakeover BidGrowth EquityRecapitalization