Buyout (Company) - Explained
What is a Corporate Buyout?
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Table of ContentsWhat is a Buyout?How does a Company Buyout Happen? Management Buyouts Versus Leveraged BuyoutsExamples of BuyoutsAcademic Research on Buyouts
What is a Buyout?
A buyout, synonymous to acquisition, refers to acquiring a controlling interest in an organization. This usually occurs when the firm decides to go private. When the companys management buys a stake, it is called a management buyout. In case, the company uses large amounts of debt for funding its buyout, it is referred to as a leveraged buyout. Key takeaways
- A buyout refers to the acquisition of a controlling or major interest in a firm.
- Management buyout occurs when the management of the company buys the stake. Leveraged buyout takes place when a big chunk of debt is utilized to finance the buyout.
- When a company plans to carry out its operations privately, buyouts take place.
How does a Company Buyout Happen?
When a company acquires at least 50% of the share of the company, it results in change of control and power, and this is where buyout takes place. Companies that have expertise in funding and facilitating buyouts either work individually or in groups. They obtain finances from institutional investors, affluent individuals or through loans. (Note: It can be the case when a buyout company is of the belief that it can offer more value to the shareholders of firm than its current managerial team.)
Management Buyouts Versus Leveraged Buyouts
Management buyout (MBO) is for big firms who wish to sell non-essential divisions of their firm, or for the private organizations whose owners plan to retire. MBO offers an exit strategy to these organizations. One can finance an MBO by using an amalgam of equity and debt obtained from buyers, financial institutions, and sometimes, from the one who sells. Leveraged buyout (LBO) considers using a certain amount of borrowed money along with the companys assets that it acquired. And the financers use this amount as collateral for loans. The firm that uses leveraged buyout may offer 1/10th of its capital as equity, and the remaining 90% to be financed by debt. This approach calls for high risk and high reward, and when the acquisition receives larger returns and cash flows, the firm will be able to pay off the interest on debt. While financing debt, the assets of the target company are used as collateral, which buyout companies can sell (mostly a portion) for paying the debt.
Examples of Buyouts
Back in 1986, the Board of Directors of Safeway saved their company from being taken over by Herbert and Robert Haft of Drug Mart. How? They allowed Kohlberg Kavis Roberts for a favorable leverage buyout of the company for $5.5 billion. Safeway took some of its money invested from its assets, and wound up not-so-profitable branches. With subtle growth in revenues and being more profitable, Safeway managed to go public in 1990. Roberts ended up receiving $7.2 billion on the amount of $129 million that he invested during LBO. Blackstone Group acquired Hilton Hotels for $26 billion with the LBO strategy in 2007. Blackstone paid $5.5 million by cash, and the remaining $20.5 through debt. Prior to 2009, Hilton faced problems due to decreasing cash flows and income. However, the situation got better when Hilton financed again at lesser rates of interest. Blackstone received a profit of $10 billion by selling Hilton.
Academic Research on Buyouts
- The impact of discounting on an auction with a buyout option: A theoretical analysis motivated by eBay's buy-it-now feature, Mathews, T. (2004). Journal of Economics,81(1), 25-52. An auction with a buyout option occurring over continuous time with rules similar to eBays buy it now option is analyzed. When auction participants make no distinction as to when a transaction occurs, the seller optimally chooses a buyout option price so high that bidders never exercise the option. However, time impatience on either side of the transaction can motivate the seller to offer an option price low enough so that the option is exercised with positive probability. Further, allowing a time impatient seller to offer such an option results in an ex ante Pareto improvement when bidders do not discount future transactions.
- Earnings management preceding managementbuyoutoffers, Perry, S. E., & Williams, T. H. (1994). Journal of Accounting and Economics,18(2), 157-179. There are frequent expressions of concern in the accounting, economics, and legal literature about managers' conflicting duties and incentives in management buyouts. This study is motivated by a concern about the managerial incentive to reduce reported earnings prior to the announcement of the buyout proposal. Our analysis of a sample of 175 management buyouts during 1981-88 provides evidence of manipulation of discretionary accruals in the predicted direction in the year preceding the public announcement of management's intention to bid for control of the company.
- A comparative analysis of leveraged recapitalization versus leveraged buyout as a takeover defense, Bae, S. C., & Simet, D. P. (1998). Review of Financial Economics,7(2), 157-172. Two types of defensive schemeleveraged buyout (LBO) and leveraged recapitalization (LR)are examined. In particular, this article examines (1) whether the two similar defensive tactics affect stockholder returns differently and (2) what firm attributes are associated with stockholder gains in LBO and LR announcements. This study finds that stocks of both LBO and LR firms, on average, exhibit significant positive abnormal returns during the announcement period, but that the latter experience substantially smaller returns than the former. This study further finds that while mitigation of agency problems associated with a firm's free cash flow is present for both LR and LBO firms, it is more pronounced for the LBO firms. These results provide evidence that a firm with higher free cash flow could benefit a greater reduction of agency costs by going private through a LBO plan than by remaining public through a LR plan.
- Farming exit decision by age group:Analysis of tobacco buyout impact in Kentucky, Pushkarskaya, H., & Vedenov, D. (2009). in Kentucky.Journal of Agricultural and Applied Economics,41(3), 653-662. This article analyzes factors that affected the decision to exit tobacco production in the wake of the tobacco buyout program using the data collected through a survey of Kentucky tobacco farmers. Using the Heuristic logistic regression model, we find that the decision to exit tobacco growing was affected by efficiency considerations, availability of off-farm employment, and exit barriers. Availability of off-farm employment had the strongest effect on farmers younger than 46, while the effect of variables measuring efficiency and exit barriers seemed to be more uniform across age groups. Based on the results we suggest several policy interventions.
- Fare thee well? An analysis of buyout funds' exit strategies, Frth, S., & Rauch, C. (2015). Financial Management,44(4), 811-849. This paper analyzes exit strategies of buyout funds in portfolio companies following initial public offerings (IPOs). We use a data set of 222 buyoutbacked IPOs in the United States from 1999 to 2008, including handcollected data about each exit process, to draw a detailed roadmap of buyout investors divestment processes. Using this data, we document the timing and aggressiveness of the exit strategies, and analyze to which degree a multitude of possible determinants influence the choice of a given exit strategy. Our results indicate that buyout funds remain invested in their portfolio companies for a substantial period of time after the IPO, and that the choice of a given exit strategy depends not only upon the characteristics of each respective portfolio company, but also on the financial success of the deal from the perspective of the buyout investor.