What are Management Buyouts?
The term buyout means an acquisition of some or all of the assets (including shares and debts) of a company by one or more other companies. In the commercial world, buyouts are investments made with the objective of realizing capital appreciation. As noted by Fintalent’s management buyouts consultants, There’s not just one kind of buyout; management buyouts (MBOs) are a type that is unique because it is often initiated and carried out by members to management personnel at a subsidiary, associate, or sister company. If you are considering joining a buyout group, it is important to understand what it is and the motivations that typically drive these deals.
A management buyout (MBO) is an acquisition of a company’s stock from existing shareholders that is carried out by the firm’s managers. This article will explore what motivates management teams to pursue MBOs and how the process works. It will also touch on potential pros and cons of MBOs for both sellers and buyers of companies.
Motivations for Management Buyouts
Management buyouts are motivated by two factors: 1) remaining in control of the company and 2) providing a return on investment for shareholders.
For one, MBOs are motivated by motivations to remain in control of the company. Management teams can also be motivated by the desire to provide a return on investment for shareholders who sell their stake in the company.
Management teams can often increase shareholder value significantly over time through various means such as increasing sales, reducing costs, and improving profit margins over time. However, one way management can provide a quick return to shareholders is through an MBO. Once a buyout is completed and there is a new investor with larger holdings than those of existing shareholders, management can begin using profits to pay out dividends or for other distribution strategies that will benefit existing shareholders. Management teams can also use MBOs for more selfish reasons, such as buying themselves some time to find a new job or simply to prove that they can run their existing business.
In addition to the motivations above, management teams are often motivated by the free cash flow available in an MBO. It is typically not uncommon for MBOs to have preceding syndicated financing. In fact, it is typical for a company seeking an MBO (or allowing an MBO) to seek out financing in order to finance the deal. In doing so, existing management (and potentially new investors) can receive debt financing for the MBO, eliminating the need for the company to pay out debt through earnings or raise more equity. This financing is usually paid back through distributions of free cash flow.
How Do Management Buyouts Happen?
The process of an MBO typically begins with a management team evaluating its future prospects under existing ownership. The process involves analyzing current business performance and future growth prospects while also taking into account risk factors such as industry risks or macroeconomic risks. Once management and the company’s board of directors decide that an MBO is the best strategy, it is typically announced to shareholders.
After the announcement, a process known as a “go shop” period begins. During a go-shop period, interested buyers are given a certain amount of time (usually 20-30 days) to submit bids for the company with an acquisition agreement in place. At this point in the process, there can be many interested buyers, although it is not uncommon for interest to dwindle over time as bidders believe they have no real chance at winning the deal due to competitive bidding or some other reason.
In the example below, each circle represents a different person involved in a management buyout: officer (A), equity banker (B), management team (C), and other interested investors (D). See also our article on buyout groups.
The Management Buyout Process
Once a management team has decided that an MBO is the best strategy to take, they will proceed with soliciting bids from potential buyers. To do so, they will attempt to encourage their current shareholders to sell their shares and accept the terms of such bids to retain ownership of the company. During this process, there is typically little pressure for existing shareholders to sell their shares and accept offers from interested buyers. However, there is often pressure placed on management to increase their offer if the company’s shareholders value the business and its prospects at a certain level.
As in all buyouts, the buyer’s stock must be valued at a premium over existing shareholders’ stock to encourage these shareholders to sell. Thus, an offer must be high enough to allow interested buyers to win the bid for their preferred price. The potential buyers are then analyzed and ranked based on their willingness and ability to pay for the company and provide a return for existing stakeholders. Prioritization of potential buyers can also be based on other factors such as fit with existing management or synergy with current business operations. Once a management team has decided on a preferred bidder, they will move to the negotiation phase.
Throughout the negotiation phase, interested buyers are given time to consider the purchase and put together a bid in hopes of winning over management and shareholders. During this time, management may work with their preferred buyer to finalize terms and reach an agreement on price/valuation and other buyout terms. This can often be a lengthy period in which many potential buyers drop out while others are encouraged to participate through competitive bidding by existing stakeholders or another interested buyer that has joined the process.
Once an agreement on price is reached between existing stakeholders and management, an acquisition agreement is drafted by lawyers representing the parties involved in the deal. During the negotiation phase, it may not be uncommon for bidders or interested buyers to make offers and change terms of these offers during negotiations. Once an agreement is reached, binding contracts are signed and the deal is done. See also our article on buyout terms. The MBO process typically ends there as a new set of buyers takes control of a company in hopes of improving its long-term prospects and creating value for shareholders.
Management buyouts (MBO) is a controversial topic, since it is seen as a selfish way of doing business. To an investor, the return on an MBO may be very high, but to the employees of the target company (or other stakeholders in that company), the MBO may be a negative one. The main difference between a management buyout and an acquisition of shares from other stockholders is that management buys out are usually made by investing in existing companies’ stock. The most common forms of MBO are acquisitions like “mergers and takeovers” (essentially buying controlling interest) and purchases through payment-in-kinds.
To summarize, MBOs are used to increase the ownership of a stake in a public company that has been undervalued by shareholders.