Leveraged Buyout - Management Buyouts

Management Buyouts

A special case of a leveraged acquisition is a management buyout (MBO). In an MBO, the incumbent management team (that usually has no or close to no shares in the company) acquires a sizeable portion of the shares of the company. Similar to an MBO is an MBI (Management Buy In) in which an external management team acquires the shares. An MBO can occur for a number of reasons; e.g.,

1. The owners of the business want to retire and want to sell the company to the management team they trust (and with whom they have worked for years)
2. The owners of the business have lost faith in the business and are willing to sell it to the management (who believes in the future of the business) in order to get some value for the business
   
3. The managers see a value in the business that the current owners do not see and do not want to pursue

In most but the smallest situations, the management team does not have enough money to fund the equity needed for the acquisition (to be combined with bank debt to constitute the purchase price) so that management teams work together with financial sponsors to part-finance the acquisition. For the management team, the negotiation of the deal with the financial sponsor (i.e., who gets how many shares of the company) is a key value creation lever. Financial sponsors are often sympathetic to MBOs as in these cases they are assured that management believes in the future of the company and has an interest in value creation (as opposed to being solely employed by the company). There are no clear guidelines as to how big a share the management team must own after the acquisition in order to qualify as an MBO, as opposed to a normal leveraged buy-out in which the management invests together with the financial sponsor. However, in the usual use of the term, an MBO is a situation in which the management team initiates and actively pushes the acquisition.

MBO situations lead management teams often into a dilemma as they face a conflict of interest, being interested in a low purchase price personally while at the same time being employed by the owners who obviously have an interest in a high purchase price. Owners usually react to this situation by offering a deal fee to the management team if a certain price threshold is reached. Financial sponsors usually react to this again by offering to compensate the management team for a lost deal fee if the purchase price is low. Another mechanisms to handle this problem are earn-outs (purchase price being contingent on reaching certain future profitabilities).

As a MBO has the potential to create considerable wealth for management team, there is a vast amount of literature on this topic (e.g., ).

There probably are just as many successful MBOs as there unsuccessful ones. Crucial for the management team at the beginning of the process is the negotiation of the purchase price and the deal structure (including the envy ratio) and the selection of the financial sponsor.