A buyout is the acquisition of a controlling interest in a company, synonymous with the term acquisition. When a firm’s management purchases the stake, it is termed a management buyout. If significant debt is used for funding, the process becomes a leveraged buyout. Buyouts frequently occur when a company chooses to go private.
Key Takeaways
- A buyout involves acquiring a controlling interest in a company, often associated with acquisition.
- Management buyouts occur when the company’s management purchases the stake.
- Leveraged buyouts are funded heavily through debt.
- Companies tend to undergo buyouts when moving towards privatization.
Understanding Buyouts
Buyouts materialize when a purchaser acquires more than 50% of a company, initiating a change in control. Specialized firms engaged in funding and orchestrating buyouts often work solo or in collaboration. They are typically financed by institutional investors, affluent individuals, or loans.
Private equity funds and investors often target underperforming or undervalued companies that they can take private, restructure, and later bring back to the public market. These buyout firms are pivotal in management buyouts (MBOs), where the company’s management participates in the acquisition. They also play essential roles in leveraged buyouts, commonly involving high levels of borrowed capital.
Partnerships often include buy-sell agreements, like shotgun clauses, compelling partners to either purchase the offering partner’s stake or sell their own shares.
Types of Buyouts
Management Buyouts (MBOs):
MBOs often serve as exit strategies for large corporations divesting non-core divisions or for private business owners nearing retirement. MBO financing is typically substantial, incorporating a mix of debt and equity sourced from buyers, financiers, and occasionally the seller.
Leveraged Buyouts (LBOs):
LBOs involve considerable borrowing, with the target company’s assets often used as loan collateral. The acquiring firm may contribute just 10% of the capital, with the rest sourced through debt. This high-risk, high-reward approach demands the acquisition to generate significant returns to cover interest payments. Assets from the target company may be sold to service debt.
Examples of Buyouts
In 1986, Safeway’s Board of Directors (BOD) warded off hostile takeovers from Herbert and Robert Haft of Dart Drug by allowing Kohlberg Kravis Roberts to finalize a friendly LBO of Safeway for $5.5 billion. Safeway shed some assets and shut down unprofitable stores, eventually returning to the public market in 1990. The deal’s profitability was evident as Roberts earned around $7.2 billion on an initial investment of $129 million.
Another remarkable example is Blackstone Group’s 2007 purchase of Hilton Hotels for $26 billion via an LBO. Blackstone invested $5.5 billion in equity and funded $20.5 billion through debt. Hilton faced declining cash flows pre-financial crisis of 2009 but later refinanced at favorable rates and enhanced operations. Blackstone eventually sold Hilton, netting close to $10 billion in profit.
Related Terms: controlling interest, going private, institutional investors, management buyout, leveraged buyout, collateral.
