A leveraged buyout (LBO) is a financial transaction in which a company is acquired using a combination of equity and debt financing. The debt financing component of an LBO allows the acquirer to use leverage (borrowed money) to fund the acquisition, hence the name “leveraged buyout.”
There are three main types of LBOs:
Management Buyout (MBO)
A management buyout (MBO) refers to an LBO in which the existing management team acquires the company they manage through a financial sponsor. The management team typically partners with a private equity firm or other financial sponsor to secure the necessary financing to fund the acquisition.
Here are some key characteristics of an MBO:
– The existing management team initiates and leads the buyout. They identify the opportunity and bring it to a private equity firm’s attention.
– Management retains an equity stake in the company post-acquisition, typically investing their own capital alongside the financial sponsor. This ensures alignment of interests.
– The private equity firm provides the majority of the financing and takes a controlling equity stake. They bring financial resources and expertise to the table.
– Employees below the management level may be offered the chance to reinvest equity stakes or given incentive compensation. This incentivizes them to support the deal.
– The company transitions from being publicly traded to being privately held. This gives management more autonomy to execute long-term strategy outside of public company pressures.
– The new private company structure allows management and investors to benefit from future company growth. The goal is to eventually sell the company or take it public again at a valuation uplift.
Some benefits of an MBO:
– Aligns management incentives with investors
– Allows management to gain majority control
– Provides company flexibility as a private entity
– Enables long-term decision-making
Some downsides of an MBO:
– Requires significant financing
– Highly leverages the company
– Concentrates equity with few participants
– Limits liquidity for non-participating shareholders
Overall, an MBO is appealing to an existing management team that wants to gain control and ownership over their company’s future direction. With the help of an investment partner, they can buy out existing shareholders and take the company private.
Management Buy-in (MBI)
A management buy-in (MBI) is another form of LBO in which an outside management teampartners with a financial sponsor to acquire a company. Unlike an MBO, the management team does not currently work for the target company.
Here are some key characteristics of an MBI:
– An external management team identifies an acquisition target and initiates the buyout.
– The management team partners with a private equity firm or other financial sponsor. The sponsor provides most of the financing.
– The new management invests a small portion of capital and takes an equity stake in the acquired company. This gives them “skin in the game.”
– The financial sponsor takes a controlling equity stake and puts up most of the financing.
– The acquisition turns the target company from being publicly traded into being privately held.
– The goal is to improve company operations under new management and eventually profit through a future exit.
Some benefits of an MBI:
– Brings in new management with fresh perspectives
– Gives incoming team “skin in the game” through equity stakes
– Allows target firm to operate outside of public markets
– Enables operational changes and long-term planning
-Profit potential through future exit
Some potential downsides of an MBI:
– Untested management team taking over
– Risk of overpaying for acquisition
– Highly leverages target company
– Limits liquidity for existing shareholders
– Potential culture clash between old and new staff
Overall, an MBI allows an outside management team to take over a company in partnership with a financial sponsor. With careful targeting and proper incentives, an MBI can be a catalyst for turning around a struggling business or maximizing the potential of a stable one.
Buy-in Management Buyout (BIMBO)
A buy-in management buyout (BIMBO) is a hybrid of an MBO and MBI. It involves both existing company management and a new external management team partnering to acquire a company.
Here are some key characteristics of a BIMBO:
– Both internal and external management partner to acquire the company.
– The existing management retains partial equity and some roles. New management supplements the team.
– A private equity firm or other financial sponsor provides most of the financing.
– The target company transitions from public to private ownership after the buyout.
– The blended management team implements changes to drive growth and improve operations.
Some benefits of a BIMBO:
– Combines internal experience with new external perspectives
– Allows coherent leadership transition when founders/CEOs leave
– Gives incoming team “skin in the game” through equity
– Enables public to private transition and operational flexibility
– Shared effort to create value and drive future exit
Some potential downsides of a BIMBO:
– Risk of tension or conflicts between old and new management
– Highly leverages the target company
– Concentrates equity with limited participants
– Limits liquidity for non-participating shareholders
– Challenging to align incentives across blended team
Overall, a BIMBO allows companies to supplement longstanding leadership with fresh talent through a buyout, ideally getting the best of both worlds. The mixed internal-external team can combine institutional knowledge with new capabilities and networks. If executed smoothly, a BIMBO can catalyze a positive new chapter in a company’s trajectory.
Examples of LBOs
Here are a few notable real-world examples of the different types of LBOs:
Management Buyout Example – Dell
In 2013, founder Michael Dell took Dell Technologies private in a $24.4 billion MBO. He partnered with private equity firm Silver Lake to acquire the company and gain flexibility outside the public markets. It went on to make major acquisitions and investments in R&D. In 2018, Dell went public again at a valuation nearly 3 times higher than in the MBO.
Management Buy-in Example – HCA
Hospital Corporation of America (HCA), a large hospital network, was acquired in a $33 billion MBI in 2006. The investment group was led by Bain Capital, KKR, and Merrill Lynch Global Private Equity. They partnered with an external management team to take over the company and turn it private. This allowed for significant changes to strategy and operations. HCA once again became a publicly traded company in 2011.
BIMBO Example – Dell EMC
When Dell merged with EMC in 2016 for $67 billion, it was structured as a BIMBO. Michael Dell maintained his leadership role along with new managers from EMC. Silver Lake again provided financing for the majority of the deal value. The blended Dell and EMC management team took on integration and shaping the combined company’s strategy.
LBO Financing
The “leveraged” component of an LBO refers to the debt financing used to fund a large portion of the acquisition price. Here is an overview of the financing structure:
– **Debt Financing** – This provides 60-90% of the funding for an LBO. The debt creates leverage and lifts equity returns. Banks provide senior debt. High yield bonds may cover some junior debt.
– **Equity Contribution** – The financial sponsor and management team provide 10-40% of the financing as an equity contribution. This equals the amount not covered by debt. The equity generates returns as the deal creates value.
– **Company Cash Flows** – The acquired company’s future cash flows are used to repay the debt over time. This debt paydown increases equity value.
– **Company Assets** – LBO deals often use company assets as collateral for loans. This reduces lender risk.
A typical LBO capital structure may look like this:
| Source | Percentage |
|---|---|
| Senior Debt | 50% |
| Junior Debt | 20% |
| Equity | 30% |
Returns in an LBO
Participants in an LBO can generate returns through the following mechanisms:
– **Operational Improvements** – Management can improve profits through revenue growth and cost optimizations. This boosts equity value.
– **Multiple Expansion** – The valuation multiple used to value the company may expand based on market conditions. This enhances equity value.
– **Debt Paydown** – Paying down debt over time concentrates equity value.
– **Dividends and Fees** – Equity holders may pull dividends out of the company. Lenders earn interest and fees.
– **Exit** – Selling the company or taking it public realizes returns for shareholders.
Properly executed LBOs generate significant equity returns from the combination of these factors. Participants benefit from the leverage involved in the deal financing.
However, failed LBOs can also wipe out equity value and leave companies bankrupt. The high leverage leaves little room for error in LBO deals.
Conclusion
In summary, the three main types of LBOs are:
– Management buyouts (MBOs) – Existing managers acquire the company they manage
– Management buy-ins (MBIs) – Outside managers partner with investors to acquire a company
– Buy-in management buyouts (BIMBOs) – Existing managers blend with new managers to buy the company
LBOs use significant debt financing to fund acquisitions. The debt creates leverage and enhances equity returns if the deal goes well. However, LBOs also concentrate risk. Management must improve operations and strategy to create value and repay lenders.
When executed smoothly, LBOs can allow management teams to unlock significant value. They provide a viable path to ownership and flexibility away from public markets. However, the risks involved must be carefully managed.