Buyout (Company) - Explained
What is a Corporate Buyout?
Written by J. Mance Gordon
Updated at April 20th, 2024
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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 company's 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.