Management buyout
Encyclopedia
A management buyout is a form of acquisition
where a company's existing managers
acquire a large part or all of the company.
aspects to any other acquisition
of a company. The particular nature of the MBO lies in the position of the buyers as managers of the company, and the practical consequences that follow from that. In particular, the due diligence
process is likely to be limited as the buyers already have full knowledge of the company available to them. The seller is also unlikely to give any but the most basic warranties to the management, on the basis that the management know more about the company than the sellers do and therefore the sellers should not have to warrant the state of the company.
In many cases the company will already be a private company, but if it is public then the management will take it private.
Some concerns about management buyouts are that the asymmetric information
possessed by management may offer them unfair advantage relative to current
owners. The impending possibility of an MBO may lead to principal–agent problems, moral hazard
, and perhaps even the subtle downward manipulation of the stock price prior to sale via adverse information disclosure, including accelerated and aggressive loss recognition, public launching of questionable projects, and adverse earning surprises.
Naturally, such corporate governance
concerns also exist whenever current
senior management is able to benefit personally from the sale of their company or its assets. This would include, for example, large parting bonuses for CEOs after a takeover or management buyout.
Since corporate valuation is often subject to considerable uncertainty
and ambiguity
, and since it can be heavily influenced by asymmetric or inside information, some question the validity of MBOs and consider them to potentially represent a form of insider trading
.
The mere possibility of an MBO or a substantial parting bonus on sale may create perverse incentive
s that can reduce the efficiency of a wide range of firms—even if they remain as public companies. This represents a substantial potential negative externality.
has been scheduled for closure or if an outside purchaser would bring in its own management team. They may also want to maximize the financial benefits they receive from the success they bring to the company by taking the profits
for themselves. This is often a way to ward off aggressive buyers.
available to buy the company outright themselves. They would first seek to borrow from a bank
, provided the bank
was willing to accept the risk
. Management buyouts are frequently seen as too risky for a bank to finance the purchase through a loan. Management teams are typically asked to invest an amount of capital that is significant to them personally, depending on the funding source/banks determination of the personal wealth of the management team. The bank then loans the company the remaining portion of the amount paid to the owner. Companies that proactively shop aggressive funding sources should qualify for total debt financing of at least four times (4X) cash flow
.
to the management. The exact financial structuring will depend on the backer's desire to balance the risk with its return, with debt
being less risky but less profitable than capital
investment.
Although the management may not have resources to buy the company, private equity houses will require that the managers each make as large an investment as they can afford in order to ensure that the management are locked in by an overwhelming vested interest in the success of the company. It is common for the management to re-mortgage their houses in order to acquire a small percentage of the company.
Private equity
backers are likely to have somewhat different goals to the management. They generally aim to maximise their return and make an exit after 3–5 years while minimising risk
to themselves, whereas the management rarely look beyond their careers at the company and will take a long-term view.
While certain aims do coincide—in particular the primary aim of profitability
—certain tensions can arise. The backers will invariably impose the same warranties on the management in relation to the company that the sellers will have refused to give the management. This "warranty gap" means that the management will bear all the risk of any defects in the company that affects its value.
As a condition of their investment, the backers will also impose numerous terms on the management concerning the way that the company is run. The purpose is to ensure that the management run the company in a way that will maximise the returns during the term of the backers' investment, whereas the management might have hoped to build the company for long-term gains. Though the two aims are not always incompatible, the management may feel restricted.
The European buyout market was worth €43.9bn in 2008, a 60% fall on the €108.2bn of deals in 2007. The last time the buyout market was at this level was in 2001 when it reached just €34bn.
This represents a disadvantage for the selling party, which must wait to receive its money after it has lost control of the company. It is also dependent on the returned profits being increased significantly following the acquisition, in order for the deal to represent a gain to the seller in comparison to the situation pre-sale. This will usually only happen in very particular circumstances.
The vendor may nevertheless agree to vendor financing for tax reasons, as the consideration
will be classified as capital gain rather than as income. It may also receive some other benefit such as a higher overall purchase price than would be obtained by a normal purchase.
The advantage for the management is that they do not need to become involved with private equity or a bank and will be left in control of the company once the consideration has been paid.
owned by Navistar (at that time, International Harvester
) which was in danger of being closed or sold to outside parties until its managers purchased the company.
In the UK, New Look
was the subject of a management buyout in 2004 by Tom Singh
, the founder of the company who had floated it in 1998. He was backed by private equity houses Apax and Permira
, who now own 60% of the company. An earlier example of this in the UK was the management buyout of Virgin Interactive from Viacom
which was led by Mark Dyne
.
The Virgin Group
has undergone several management buyouts in recent years. On September 17, 2007, Sir Richard Branson announced that the UK arm of Virgin Megastores was to be sold off as part of a management buyout, and from November 2007, will be known by a new name, Zavvi. On September 24, 2008, another part of the Virgin group, Virgin Comics underwent a management buyout and changed its name to Liquid Comics
. In the UK and Ireland, Virgin Radio
also underwent a similar process and became Absolute Radio.
Takeover
In business, a takeover is the purchase of one company by another . In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.- Friendly takeovers :Before a bidder makes an offer for another...
where a company's existing managers
Management
Management in all business and organizational activities is the act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively...
acquire a large part or all of the company.
Overview
Management buyouts are similar in all major legalLaw
Law is a system of rules and guidelines which are enforced through social institutions to govern behavior, wherever possible. It shapes politics, economics and society in numerous ways and serves as a social mediator of relations between people. Contract law regulates everything from buying a bus...
aspects to any other acquisition
Mergers and acquisitions
Mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or...
of a company. The particular nature of the MBO lies in the position of the buyers as managers of the company, and the practical consequences that follow from that. In particular, the due diligence
Due diligence
"Due diligence" is a term used for a number of concepts involving either an investigation of a business or person prior to signing a contract, or an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations...
process is likely to be limited as the buyers already have full knowledge of the company available to them. The seller is also unlikely to give any but the most basic warranties to the management, on the basis that the management know more about the company than the sellers do and therefore the sellers should not have to warrant the state of the company.
In many cases the company will already be a private company, but if it is public then the management will take it private.
Some concerns about management buyouts are that the asymmetric information
Information asymmetry
In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry, a kind of market failure...
possessed by management may offer them unfair advantage relative to current
owners. The impending possibility of an MBO may lead to principal–agent problems, moral hazard
Moral hazard
In economic theory, moral hazard refers to a situation in which a party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party insulated from risk behaves differently from how it would if it were fully exposed to the risk.Moral hazard...
, and perhaps even the subtle downward manipulation of the stock price prior to sale via adverse information disclosure, including accelerated and aggressive loss recognition, public launching of questionable projects, and adverse earning surprises.
Naturally, such corporate governance
Corporate governance
Corporate governance is a number of processes, customs, policies, laws, and institutions which have impact on the way a company is controlled...
concerns also exist whenever current
senior management is able to benefit personally from the sale of their company or its assets. This would include, for example, large parting bonuses for CEOs after a takeover or management buyout.
Since corporate valuation is often subject to considerable uncertainty
Uncertainty
Uncertainty is a term used in subtly different ways in a number of fields, including physics, philosophy, statistics, economics, finance, insurance, psychology, sociology, engineering, and information science...
and ambiguity
Ambiguity
Ambiguity of words or phrases is the ability to express more than one interpretation. It is distinct from vagueness, which is a statement about the lack of precision contained or available in the information.Context may play a role in resolving ambiguity...
, and since it can be heavily influenced by asymmetric or inside information, some question the validity of MBOs and consider them to potentially represent a form of insider trading
Insider trading
Insider trading is the trading of a corporation's stock or other securities by individuals with potential access to non-public information about the company...
.
The mere possibility of an MBO or a substantial parting bonus on sale may create perverse incentive
Perverse incentive
A perverse incentive is an incentive that has an unintended and undesirable result which is contrary to the interests of the incentive makers. Perverse incentives are a type of unintended consequences.- Examples :...
s that can reduce the efficiency of a wide range of firms—even if they remain as public companies. This represents a substantial potential negative externality.
Purpose
The purpose of such a buyout from the managers' point of view may be to save their jobs, either if the businessBusiness
A business is an organization engaged in the trade of goods, services, or both to consumers. Businesses are predominant in capitalist economies, where most of them are privately owned and administered to earn profit to increase the wealth of their owners. Businesses may also be not-for-profit...
has been scheduled for closure or if an outside purchaser would bring in its own management team. They may also want to maximize the financial benefits they receive from the success they bring to the company by taking the profits
Profit (accounting)
In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...
for themselves. This is often a way to ward off aggressive buyers.
Debt Financing
The management of a company will not usually have the moneyMoney
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
available to buy the company outright themselves. They would first seek to borrow from a bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
, provided the bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
was willing to accept the risk
Financial risk
Financial risk an umbrella term for multiple types of risk associated with financing, including financial transactions that include company loans in risk of default. Risk is a term often used to imply downside risk, meaning the uncertainty of a return and the potential for financial loss...
. Management buyouts are frequently seen as too risky for a bank to finance the purchase through a loan. Management teams are typically asked to invest an amount of capital that is significant to them personally, depending on the funding source/banks determination of the personal wealth of the management team. The bank then loans the company the remaining portion of the amount paid to the owner. Companies that proactively shop aggressive funding sources should qualify for total debt financing of at least four times (4X) cash flow
Cash flow
Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...
.
Private Equity Financing
If a bank is unwilling to lend, the management will commonly look to private equity investors to fund the majority of buyout. A high proportion of management buyouts are financed in this way. The private equity investors will invest money in return for a proportion of the shares in the company, though they may also grant a loanLoan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
to the management. The exact financial structuring will depend on the backer's desire to balance the risk with its return, with debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
being less risky but less profitable than capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
investment.
Although the management may not have resources to buy the company, private equity houses will require that the managers each make as large an investment as they can afford in order to ensure that the management are locked in by an overwhelming vested interest in the success of the company. It is common for the management to re-mortgage their houses in order to acquire a small percentage of the company.
Private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
backers are likely to have somewhat different goals to the management. They generally aim to maximise their return and make an exit after 3–5 years while minimising risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
to themselves, whereas the management rarely look beyond their careers at the company and will take a long-term view.
While certain aims do coincide—in particular the primary aim of profitability
Profit (accounting)
In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...
—certain tensions can arise. The backers will invariably impose the same warranties on the management in relation to the company that the sellers will have refused to give the management. This "warranty gap" means that the management will bear all the risk of any defects in the company that affects its value.
As a condition of their investment, the backers will also impose numerous terms on the management concerning the way that the company is run. The purpose is to ensure that the management run the company in a way that will maximise the returns during the term of the backers' investment, whereas the management might have hoped to build the company for long-term gains. Though the two aims are not always incompatible, the management may feel restricted.
The European buyout market was worth €43.9bn in 2008, a 60% fall on the €108.2bn of deals in 2007. The last time the buyout market was at this level was in 2001 when it reached just €34bn.
Seller Financing
In certain circumstances it may be possible for the management and the original owner of the company to agree a deal whereby the seller finances the buyout. The price paid at the time of sale will be nominal, with the real price being paid over the following years out of the profits of the company. The timescale for the payment is typically 3–7 years.This represents a disadvantage for the selling party, which must wait to receive its money after it has lost control of the company. It is also dependent on the returned profits being increased significantly following the acquisition, in order for the deal to represent a gain to the seller in comparison to the situation pre-sale. This will usually only happen in very particular circumstances.
The vendor may nevertheless agree to vendor financing for tax reasons, as the consideration
Consideration
Consideration is the central concept in the common law of contracts and is required, in most cases, for a contract to be enforceable. Consideration is the price one pays for another's promise. It can take a number of forms: money, property, a promise, the doing of an act, or even refraining from...
will be classified as capital gain rather than as income. It may also receive some other benefit such as a higher overall purchase price than would be obtained by a normal purchase.
The advantage for the management is that they do not need to become involved with private equity or a bank and will be left in control of the company once the consideration has been paid.
Examples
A classic example of an MBO involved Springfield Remanufacturing Corporation, a former plant in Springfield, MissouriSpringfield, Missouri
Springfield is the third largest city in the U.S. state of Missouri and the county seat of Greene County. According to the 2010 census data, the population was 159,498, an increase of 5.2% since the 2000 census. The Springfield Metropolitan Area, population 436,712, includes the counties of...
owned by Navistar (at that time, International Harvester
International Harvester
International Harvester Company was a United States agricultural machinery, construction equipment, vehicle, commercial truck, and household and commercial products manufacturer. In 1902, J.P...
) which was in danger of being closed or sold to outside parties until its managers purchased the company.
In the UK, New Look
New Look (store)
New Look is a British global fashion retailer with a chain of high street shops in Britain, Belgium, France, The Netherlands, Republic of Ireland, Malta, Singapore and the United Arab Emirates.-History:...
was the subject of a management buyout in 2004 by Tom Singh
Tom Singh
Tom Singh OBE is the founder of the New Look chain of high street fashion stores in the United Kingdom. He is the eldest brother of author and broadcaster Dr Simon Singh. He is a graduate of the University of Wales....
, the founder of the company who had floated it in 1998. He was backed by private equity houses Apax and Permira
Permira
Permira is a United Kingdom-based private equity firm with global reach. The firm advises funds with a total committed capital of approximately €20 billion....
, who now own 60% of the company. An earlier example of this in the UK was the management buyout of Virgin Interactive from Viacom
Viacom
Viacom Inc. , short for "Video & Audio Communications", is an American media conglomerate with interests primarily in, but not limited to, cinema and cable television...
which was led by Mark Dyne
Mark Dyne
Mark Dyne is Chairman and CEO of Europlay Capital AdvisorsHe has also served as CEO of Sega Gaming Technologies and Sega Ozisoft Pty Ltd., CEO and Chairman of Virgin Interactive...
.
The Virgin Group
Virgin Group
Virgin Group Limited is a British branded venture capital conglomerate organisation founded by business tycoon Richard Branson. The core business areas are travel, entertainment and lifestyle. Virgin Group's date of incorporation is listed as 1989 by Companies House, who class it as a holding...
has undergone several management buyouts in recent years. On September 17, 2007, Sir Richard Branson announced that the UK arm of Virgin Megastores was to be sold off as part of a management buyout, and from November 2007, will be known by a new name, Zavvi. On September 24, 2008, another part of the Virgin group, Virgin Comics underwent a management buyout and changed its name to Liquid Comics
Liquid Comics
Liquid Comics is a comic book company, founded in 2006 as Virgin Comics LLC, which produced stories for an international audience. The company was founded by Sir Richard Branson and his Virgin Group, author Deepak Chopra, filmmaker Shekhar Kapur, and entrepreneurs Sharad Devarajan, Suresh...
. In the UK and Ireland, Virgin Radio
Virgin Radio
Absolute Radio is one of the UK's three Independent National Radio stations. The station rebranded to its current name at 7.45am on 29 September 2008.The station is based in London and plays popular rock music...
also underwent a similar process and became Absolute Radio.
See also
- TakeoverTakeoverIn business, a takeover is the purchase of one company by another . In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.- Friendly takeovers :Before a bidder makes an offer for another...
- Management buy-inManagement buy-inA management buy-in occurs when a manager or a management team from outside the company raises the necessary finance, buys it, and becomes the company's new management. A management buy-in team often competes with other purchasers in the search for a suitable business...
- Leveraged buyoutLeveraged buyoutA leveraged buyout occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage...
- Envy ratioEnvy ratioEnvy ratio in finance is the ratio of the price paid by investors to that paid by the management team for their respective shares of the equity. This metric is used when considering an opportunity for a management buyout...
- Buy-in-Management-Buy-Out
External links
- Definition of management buyout
- Definition of buy-in management buyout
- Creative Management Buyout Strategies Article"