Buyout of Acquisitions

The concept of "Buyout of Acquisitions" primarily revolves around the processes involved in leveraged buyouts (LBOs) and management buyouts (MBOs). These transaction types have been integral to corporate finance since the 1970s and are characterized by the acquisition of companies, often primarily financed through borrowed funds. LBOs allow buyers to control large firms with minimal upfront capital, while MBOs involve the existing management team taking ownership, typically with external financial support.

Key players in these transactions include buyers, sellers, and investors, each with distinct roles and motivations. Buyers may consist of private equity firms or corporate entities aiming to enhance their business performance, whereas sellers often seek to exit ownership, either partially or fully. Investors in this space range from private equity firms and venture capitalists to angel investors, who provide essential funding during various business stages.

The appeal of these buyouts lies in their potential for high returns and operational continuity, as experienced management teams often remain in control post-acquisition. However, these transactions can also result in significant changes in a company's structure and independence. Overall, understanding the dynamics of buyouts is crucial for anyone exploring corporate mergers and acquisitions.

Published in: 2021

By: Gould, Marie

Subject Terms

Buyout of Acquisitions

This article focuses on acquisitions, especially leveraged and management buyouts. These types of transactions are very unique, and have been around since the 1970s. There is a discussion of Frankel's strategic transaction process. There are several types of investors. Two types of private capital equity are venture capitalists and angel investors.

Keywords Acquisition; Angel Investors; Investments; Leveraged Buyout; Management Buyout; Merger; Venture Capitalists

Finance > Buyout of Acquisitions

Overview

"Merger and acquisitions, buyouts, leveraged buyouts (LBOs), management buyouts (MBOs), private equity, venture capital, corporate development, and a myriad of other terms are used to describe large transactions that fundamentally change the nature or course, and control, of a company" (Frankel, 2005, p. ix). However, this article focuses on leveraged buyouts and management buyouts. These types of transactions are very unique, and have been around since the 1970s. Once a rarity, it is very common for a business to be bought out in order to strengthen its worth. Unlike other commercial contracts and agreements, these types of transactions tend to be dramatic and sudden with many businesses losing their independence once the deal has been sealed.

The Players

According to Frankel (2005), all of the transactions have some things in common even though the focus and process may be different. Who are the key players in what Frankel calls the "Strategic Transactions" process? These players are the buyer, the seller, investors/owners, corporate staff, advisors, regulators, and others. However, this article will focus on the buyers, sellers, and investors/owners.

Buyers

The buyer usually refers to a group of individuals that form an entity in order to maximize the interest of the corporation and the shareholders. There are many types of buyers, which include: Strategic buyers, repeat players, newbies or one timers, financial buyers, private equity firms, and management buyers.

Strategic buyers are usually corporations that are interested in making an acquisition in order to strengthen and upgrade their poor business performance.
Repeat players tend to go through the acquisition process more than once. As a result, they can recognize what they have done well and strive to improve what they do not do well.
Most first time buyers are nervous in the beginning, but strive to get the experience of making strategic transactions so that they can become repeat buyers.
Financial buyers tend to use some form of investor capital in order to acquire control over a target company with the goal of selling the company for a profit.
Private equity firms are firms that collect a pool of capital from others and then make investments in a portfolio of companies.
Management buyers tend to partner with a private equity firm in order to acquire a company.

Sellers

As a rule, sellers do not plan to be in the acquisition business for the long term. Rather, they tend to be in the process for one time only. Selling the corporation is the final step of the shareholders. There are three types of sellers: Partial sellers, full sellers, and unwilling sellers. Many acquisitions involve the sale of part of the company versus the whole thing.

In most cases, partial sales are usually the first step in a series of transactions of selling the entire company.
Full sellers have a desire to get rid of the company as soon as possible.
Unwilling sellers may be the target of another company and the process can be hostile.

Investors/Owners

There are several types of investors. However, this article will focus on entrepreneurs, private equity, angels, venture capitalists, leveraged buyout and management buyout firms. Entrepreneurs are very creative. Many seek to see their vision become a reality. Once the business is successful, they may decide to "step aside" and let the management team run the company. Many businesses are started with the capital of the founders. However, once the business gets started, they may find that they need additional funding and seek the assistance of private equity firms. Two types of private capital equity are venture capitalists and angel investors.

Venture Capitalists Venture capital is usually available for start-up companies with a product or idea that may risky, but has a high potential of yielding above average profits. Funds are invested in ventures that have not been discovered. The money may come from wealthy individuals, government sponsored Small Business Investment Corporations (SBICs), insurance companies, and corporations. It is more difficult to obtain financing from venture capitalists. A company must provide a formal proposal such as a business plan so that the venture capitalist may conduct a thorough evaluation of the company's records. Venture capitalists only approve a small percentage of the proposals that they receive, and they tend to favor innovative technical ventures.

Funding may be invested throughout the company's life cycle with funding being provided at both the beginning and later stages of growth. Venture capitalists may invest at different stages. Some firms may invest before the idea has been fully developed while others may provide funding during the early stages of the company's life. However, there is a group of venture capitalists who specialize in assisting companies when they have reached the point when the company needs financing in order to expand the business. Finally, the venture capitalists may provide funding in order to buy (acquire) a business.

Angel Investors Many firms receive some type of funding prior to seeking capital from venture capitalists. Angel Investors have been identified as one source that organizations, especially entrepreneurs, may reach out to for assistance (Gompers, 1995). "In a nationwide survey of more than 3,000 individual angel investors conducted by the Angel Capital Association, more than 96 percent predict they'll invest in at least one new company in 2007. Also, 77 percent expect to invest in three to nine startups, and five percent think they'll fund 10 or more new companies" (Edelhauser, 2007, “Angel”). This is beneficial for future entrepreneurs who have a dream they would like to pursue.

Including angel investors in the early stages of financing could improve the chances of receiving venture capital financing. Madill, Haines and Rlding (2005) conducted a study with small businesses and found that “57% of the firms that had received angel investor financing had also received financing from venture capitalists” (p. 107). Firms that did not receive angel investing in the early stages (approximately 10% of the firms in the study) did not obtain venture capital funding. It appears that angel investor financing is a significant factor in obtaining venture capital funding. Since obtaining venture capital tends to be difficult, businesses can benefit from the contacts and experience of angel investors in order to prepare for a venture capital application and evaluation. The intervention of an angel investor may make the company appear more attractive to the venture capitalists.

Forming an Agreement

Regardless of how a company decides to finance the venture, it will have to make an agreement that is beneficial to the investor since they are the ones providing the money. Therefore, it is important to select a choice that benefits the business in the long run. Initial decisions may set the tone for future deals. Advani (2006) has provided some recommendations to consider when determining what will work best. These suggestions include:

Don't give pro-rata rights to your first investors. If your first investor is given pro-rata rights, chances are your future investors will want the same agreement. It would be wise to balance the needs of your early investors to protect their stake in the company with how attractive the company will be to future investors.
Avoid giving too many people the right to be overly involved. If too many people are involved, it could create a bureaucracy and make it difficult for decisions to be made in a timely manner. In addition, the daily tasks of a business may be prolonged due to the need for multiple authorization signatures.
Beware of any limits placed on management compensation. Some investors may place a cap on the earning potential of senior management personnel. This type of action could create a problem with human resource needs such as attracting and hiring quality talent to run and grow the business.
Request a cure period. Many investors will request representation for every legal agreement to protect themselves if the management of a company is not in compliance with laws, licenses, and regulations that govern the operation of the business. Although all parties may have good intentions, errors do occur. If a "cure period" is added to the financing agreement, the entrepreneur will have the opportunity to find a solution to the problem within a given period of time (i.e. two to four weeks).
Restrict your share restrictions. Having unrestricted shares is often a good negotiating factor with future investors. Therefore, it would be wise to evaluate any requests to restrict the sale of shares owned by the founders and/or management team.

Application

Leveraged & Management Buyouts

A leveraged buyout is the process of acquiring a company where the purchase price is financed by borrowing money. The major advantage of a LBO is that a buyer can purchase a large company with a small amount of money. Another form of a private equity acquisition is the MBO. In an MBO, the management team acquires the company with funding that comes from their personal finances combined with funding from a private equity firm.

As mentioned in the previous section, buyouts tend to occur when an entity borrows money in order to acquire a company. It may be a private equity firm or it may be a combination of the private equity firm with the management team of the organization.

The Appeal of Leveraged Buyouts

According to Dartmouth College's Center for Private Equity and Entrepreneurship (2003), leveraged buyouts have a number of appealing characteristics for managers. Some of these characteristics include:

Tax advantages associated with debt financing;
Freedom from the scrutiny of being a public company or a captive division of a larger parent;
The ability for founders to take advantage of a liquidity event without ceding operational influence or sacrificing continued day-to-day involvement; and
The opportunity for managers to become owners of a significant percentage of a firm's equity (p. 3).

Many considering whether or not to pursue a LBO/MBO acquisition may be swayed by the following advantages:

Internal process and transfer of responsibilities remain confidential and are often handled quickly.
Continuity with the company's business will reduce the risk.
Experienced management team understands the needs of the business.
The company's existing clients and business partners are reassured.
Opportunity to obtain interesting return on investment (BDC, nod., p. 1).

Steps to LBO & MBO Transfers

Some of the common steps that need to be taken in order to transfer power include:

Buyer and seller agree on a sale price that may result in a win-win transaction.
A valuation of the business confirms the agreed upon price.
Managers assess the portion of the shares that can be purchased immediately and draft the shareholder agreement.
Financial institutions are approached.
A transition plan is developed that incorporates tax and succession planning.
Managers buyout the owner's interest with financial support.
Decision-making and ownership powers are transferred to the successors. This process can take place gradually over a period of a few months or a few years.
Managers pay back the financial institution (BDC, n.d. p. 2).

In order to be successful, there are steps that a LBO and MBO must take. For example, a LBO should:

Research the company to be purchased and make sure that the company's assets are sufficient to secure the necessary loans
Make sure that the management team is strong and will continue with the company once the buyout has taken place
Hire a professional to act as a middleman in the negotiations with the management team, shareholders, potential investors and board members
Assemble a team of leveraged buyout specialists, investment bankers, accountants and attorneys (eHow, n.d., “Step 1 – 5”).

When there is an opportunity for a MBO acquisition, the team of managers will need to make sure that (ThisIsMoney, n.d):

They possess a diverse spread of skills and talents.
The business is viable.
The existing owner of the business is willing to sell.
A realistic price for the business has been established.

Conclusion

"Merger and acquisitions, buyouts, leveraged buyouts (LBOs), management buyouts (MBOs), private equity, venture capital, corporate development, and a myriad of other terms are used to describe large transactions that fundamentally change the nature or course, and control, of a company" (Frankel, 2005, p. ix). However, this article focuses on leveraged buyouts, management buyouts, and employee buyouts. These types of transactions are very unique, and have been around since the 1970s. Once a rarity, it is very common for a business to be bought out in order to strengthen its worth. Unlike other commercial contracts and agreements, these types of transactions tend to be dramatic and sudden with many businesses losing their independence once the deal has been sealed.

Every entrepreneur believes in the success of their dream, and they expect their ventures to take off and expand. One of the greatest challenges for new ventures is the ability to secure capital for investments that will allow the company to grow. All projects will reach a crossroad where sufficient cash flow is necessary in order to go to the next level. It could be after a period of time or it could be because the venture was so popular and the company is growing at a rapid rate due to demand. Regardless of the situation, the company's management team will need to determine when and how they will invest in items such as purchasing new equipment, hiring new staff and putting more money into marketing initiatives. Raising money can be a difficult task if the company has not established a reputation or is still new.

When determining the amount of capital needed, the decision makers must analyze the situation and decide how much and what type of capital is required. Since the situation is not the same for all businesses, there is no magical formula. Some businesses may only need short term financing for items such as salaries and inventory; whereas, other businesses may need long term financing for major items such as office space and equipment. Each business must develop a customized plan that will meet its unique needs.

Securing capital is a choice made after weighing the pros and cons of various options. There are three popular sources for obtaining funding for new ventures: Borrowing from financial institutions, partnering with venture capitalists, and selling equity/ownership in exchange for a share of the revenue (Goel & Hasan, 2004). All financing options can be classified into two categories — debt financing and equity capital.

Many considering whether or not to pursue a LBO/MBO acquisition may be swayed by the following advantages:

Internal process and transfer of responsibilities remain confidential and are often handled quickly.
Continuity with the company's business will reduce the risk.
Experienced management team understands the needs of the business.
The company's existing clients and business partners are reassured.
Opportunity to obtain interesting return on investment (BDC, n.d., p. 1).

Some of the common steps that need to be taken in order to transfer power include (BDC, nod. p. 2):

Buyer and seller agree on a sale price that may result in a win-win transaction.
A valuation of the business confirms the agreed upon price.
Managers assess the portion of the shares they could purchase immediately and draft the shareholder agreement.
Financial institutions are approached.
A transition plan is developed that incorporates tax and succession planning.
Managers' buyout the owner's interest with financial support.
Decision-making and ownership powers are transferred to the successors. (This process can take place gradually over a period of a few months or a few years.)
Managers pay back the financial institution.

Terms & Concepts

Acquisition: Acquisition, or takeover, is known as the obtainment of control of a business or target by purchasing or exchanging stock through friendly or hostile means.

Angel Investors: Angel or Angel Investor is defined as someone who offers and provides capital to one or more startup institutions or corporations. The provided capital is constituted from beneficial and powerful contacts and a superior expertise in the field.

Investments: The attainment of a portion of a financial product or item of value that is made in the hopes of receiving larger returns in the future. Generally, investment is using and risking money in order for it to grow and replicate over time.

Leveraged Buyout: The takeover of a corporation or control over the interests of a business by utilizing a sum of borrowed money. The business’s assets usually stand as collateral for the money that is loaned.

Management Buyout: Defined as the acquisition of all or part of a business made by the company’s own managers or executives.

Merger: The combination of two or more corporations into one, usually as a result of a purchase or joining of interests. Mergers differ from consolidations because mergers are simply joined together, and a new entity is not created.

Venture Capitalists: A term that defines a type of investor who offers capital to start up ventures or smaller businesses with potential for expansion, but does so without the aid of public funding.

Bibliography

Advani, A. (2006, November 10). Start-up financing trends for 2007. Entrepreneur.com. Retrieved April 9, 2007, from http://www.entrepreneur.com/money/financing/startupfinancingcolumnistasheeshadvani/article170218.html

Advani, A. (2006, October 12). Raising money from informal investors. Entrepreneur.com. Retrieved April 9, 2007, from http://www.entrepreneur.com/money/financing/startupfinancingcolumnistasheeshadvani/article168860.html

The Business Development Bank of Canada. (n.d.). Management buyout demystified. Retrieved September 27, 2007, from http://www.bdc.ca/en/my%5fproject/Projects/articles/acquisition%5fmbo.htm

Center For Private Equity and Entrepreneurship. (2003, September 30). Note on leveraged buyouts. Retrieved September 27, 2007, from http://mba.tuck.dartmouth.edu/pecenter/research/pdfs/LBO%5fNote.pdf

Edelhauser, K. (2007, April 11). Angel investing to grow in '07. Entrepreneur.com. Retrieved April 11, 2007, from www.entrepreneur.com/blog/entry/176926.html

Frankel, M. (2005). Mergers and acquisitions basics: The key steps of acquisitions, divestitures, and investments. Hoboken, NJ: John Wiley & Sons, Inc.

Goel, R. K., & Hasan, I. (2004). Funding new ventures: Some strategies for raising early finance. Applied Financial Economics, 14, 773-778. Retrieved on April 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=13867653&site=ehost-live

Gompers, P. A. (1995). Optimal investment, monitoring, and the staging of venture capital. Journal of Finance, 50, 1461-1490. Retrieved on April 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9601031352&site=bsi-live

Guo, S., Hotchkiss, E. S., & Song, W. (2011). Do buyouts (still) create value?. Journal of Finance, 66, 479-517. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=59527270&site=ehost-live

How to perform a leveraged buyout. (n.d.). eHow. Retrieved September 27, 2007, from http://www.ehow.com/how%5f15345%5fperform-leveraged-buyout.html

Madill, J., Haines Jr., G., & Rlding, A. (2005). The role of angels in technology SMEs: A link to venture capital. Venture Capital, 7, 107-129. Retrieved Saturday, April 14, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=16968283&site=ehost-live

Management buyouts. (n.d.). Thisismoney.co.uk. Retrieved September 27, 2007, from http://www.thisismoney.co.uk/help-and-advice/advice-banks/article.html?in%5fadvicepage%5fid=129&in%5farticle%5fid=394273&in%5fpage%5fid=90

Wirz, M. (2012, December 17). Debt loads climb in buyout deals. Wall Street Journal - Eastern Edition. pp. C1-C2. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=84339238&site=ehost-live

Buyout of Acquisitions

On this Page

Subject Terms

Buyout of Acquisitions

Finance > Buyout of Acquisitions

Overview

The Players

Buyers

Sellers

Investors/Owners

Forming an Agreement

Application

Leveraged & Management Buyouts

The Appeal of Leveraged Buyouts

Steps to LBO & MBO Transfers

Conclusion

Terms & Concepts

Bibliography

Suggested Reading