What is an Institutional Buyout (IBO)?

An institutional buyout takes place when an institutional investor like venture capital company, financial organization, etc. acquires a controlling interest in a firm. Buyouts can be seen in the case of public firms that are going private. Also, private firms can encounter buyout through direct sales. Institutional buyouts work in contrast to management buyouts where the existing management of a company takes a controlling interest in either a portion or the whole company.

How does an Institutional Buyout Work? 

Institutional buyouts can be a result of agreement between the current owners of the company. But in the absence of any agreement among the management, these can lead to hostile acquisitions. It is up to the institutional buyers to keep the existing management of the organization after the acquisition takes place. Usually, they hire new talent and offer them a share in the company. 

Usually, the private equity organization heads or initiates in terms of designing and closing the contract. Institutional buyers usually hold expertise in a particular set of sectors and target a selected contract size. Organizations that have not used their borrowing capacity to the maximum level, are not performing up to the par but are still more liquid in nature having consistent cash flows and less capital expenditure, tend to be catchy buyout targets. 

Most of the times, acquiring investors involved in a buyout will sell their share to a strategic buyer or will issue it in an initial public offering. Institutional buyers usually aim for a specific period of time varying between 5-7 years and have a planned investment return hurdle for the activity involved.

Leveraged Buyouts

Institutional buyouts are referred to as leveraged buyouts, or LBOs, when there is a high level of financial leverage. In other words, it means that they comprise mostly of debts or borrowed money. Leverage can vary anywhere from 4 to 7 times.

If there is a high degree of leverage involved in LBOs, it signifies more risk associated with deal loss, and sometimes, bankruptcy when the owners running their recent startups are not able to set discipline in the price paid, or are not able to implement planned developments in business with rising operational efficiency and decreasing expenses or costs so as to pay out debts taken from financial institutions. 

The LBO market reached its maximum level in the late 1980s with many finished contracts. The popular acquisition of RJR Nabisco by KKR in the year 1988 is known as the biggest leveraged buyout of that era. It was worth $25 billion and used its debts in order to finance over 90% of its transaction expenses.