Management Buy Out
Involves the purchase of all or part of a company by its existing management team, usually with the help of external financing
Types of Management Buy Out
- Management Buy Out (“MBO”)
- Management Buy In
- Buy In / Management Buy Out (“BIMBO”)
- Leveraged Buy Out (“LBO”)
- Institutional Buy Out (“IBO”)
- Public to Private (“P2P”) - where company is undervalued by the stock markets; where the listing
does not provide any tangible benefits. - Secondary Buy Out
- Rescue / Turnaround Buy Out
Management buyouts model
- Close partnership and trust between management team and investors / lenders
- Buyout financial structure carefully tailored to cash and profit generating characteristics of company
- Management and investors share clear objectives: focus on strategic and operational priorities
- Ownership structure reinforces management team’s motivation to achieve objectives
- Value-added involvement by investor in strategic and operational decisions.
Three routes to creating value in a MBO
- Use Surplus Cash to Repay Debt (Financial Engineering approach)
Debt availability
Low interest rates
Stable companies
Limited competition - Grow Profits (Earnings enhancement approach)
Poorly managed targets
Growth sectors
Operational skills - Buy and sell at different profit multiples (Multiple arbitrage approach)
Rising markets
M&A skills
Operational skills: value creation
Process improvement
- working capital
- location(s)
- outsourcing
Growth initiatives
- sales organisation
- marketing
- new products / services
- exports
Strategic M&A
- new geographic and sector markets
- industry consolidation
MBO process
- Initial discussions between vendors and management team
- (Independent) valuation of business
- Information memo prepared
- Identify potential investors
- Initial due diligence
- Negotiate terms of deal
- Offer letter / term sheet
- Final (external) due diligence
- Shareholders’ agreement
- Closing
Leveraged acquisitions / LBOs
- Special purpose vehicle – local or offshore incorporation – makes acquisition
- SPV capital provided by PE fund, MBO, MBI team – funds only committed when acquisition takes place
- Bank finance to part fund purchase of target / provide working capital
- Bank security is target’s real estate, operating assets, book debts plus charge from SPV over capital it will hold in target.
Simple buy-out structure
In order to effect the buyout a new special purpose company is formed (New Co).
New Co buys the company that is the subject of the MBO (Target Co).
The equity and debt that is used to finance the acquisition of Target Co (provided by the PE firm, management team and banks), and paid to the Target Co parent company that is selling Target Co, is placed into New Co.
This finance is committed at the same time the acquisition takes place. The debt is leveraged on the assets of Target Co and is paid back over the life of the loan from the cash generated by Target Co’s business.
Leveraged acquisitions / LBOs (continued)
Debt helps maximise equity returns
Debt can be from 70% to 95% of finance required
Concern re sustainability of debt levels
Higher purchase multiples resulting in higher leverage
Need enhanced earnings to service debt burden
Range of debt products incl mezzanine / subordinated debt and high yield bonds – ranking behind senior debt
Senior debt: revolving loan, term loans, capex term loan
Hedge funds involved in leveraged finance and as equity sponsors
Possibility of vendor financing over (eg) 3-7 years, or Earn-Out (deferred purchase consideration).
Risk and Reward on Financial Instruments
Risk and Return increase at each of these levels incrementally:
Cash - Low Risk, Low Return (basically none for each)
Senior Debt
Junior Debt
Mezzanine
Unsecured loan stock - moderately high risk, low return
Preference shares - high risk, low return
Equity - high risk, high return
Senior Debt
Priority for interest and principal payments
Secured over all assets of borrower
Senior debt A,B and C categories
Typically repaid over 7 years (A debt)
Interest at 250 to 400 basis points over Libor
Fixed term revolving credit / overdraft for working capital
Second lien debt – part of senior debt structure, secured, ranks behind A,B,C debt. Repayable in single repayment after 10 years
Junior debt – ranks behind senior debt
Working capital facility as part of senior debt – structured as revolving credit facility or overdraft. Will have fixed term arrangement – provided no default lenders cannot withdraw facility.
Mezzanine debt
- Subordinated to senior (and junior) debt
- Interest: 15-20% pa; cash and rolled-up into principle
- Equity kicker
- Security: charges rank after senior debt
High yield bonds
- Fixed rate: 5% to 6% above government bonds
- Usually unsecured
- Sold on public debt markets
- Minimum amount around €150 million
- Penalties for early repayment
- Sub-investment grade: below S&P AAA to BBB- ; Moody Aaa to Baa3
Institutional debt - Shareholder loan notes
- Integral part of equity investment, not stand alone
- Subordinated to all other debt
- Unsecured
- Much higher risk than debt but not necessarily reflected by higher interest rates
- Principal (and typically interest) repaid on exit
Investment criteria for buyout company
Strategy and market positioning
- defensible market position
- dominant presence in mature market
- clear exit route
Company
- profits convert to cash
- historical sales and profit growth
- cost control culture
- independently viable
Management team
- operate independent of parent
- strategic awareness
- shared objectives
- financial sophistication
Other considerations with buyouts
- Buyers have full knowledge of company – resulting in reduced due diligence, reduced vendor warranties
- Perception that buyout team has unfair advantage over other parties
- Conflicts of interest, principal-agent, moral hazard, stock price manipulation issues
- Restrictive covenants from vendor in favour of purchaser / non-compete
VC deals vs. MBOs
Fund size: 50 - 500m vs. Up to 25bn
Average investment size: 1.8m vs. 65m
Typical investor stake: 20%+ vs. 80%+
Risk: Higher vs. Lower
Expected return: 30 - 50%pa vs. ~20%pa
Actual return: 14%pa vs. 11 - 14%pa
Stage: Early vs Late
Typical sectors: IT/Lifesciences vs <– + Consumer/Industries
Share of PE deals: 80% deals / 20% investment vs 20% deals / 80% investment
Management team: Usually less experienced vs Usually more experienced
Firm role: Value add vs Operational improvements / financial engineering
Debt: None or little vs High debt/equity ratio
