Management Buy Outs

What type of financing do MBOs use?

Debt

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How much do mgt seek from MBO?

50%+

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What do mgt buy out in a MBO

Purchase significant shareholdin the company or a division fo the company

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Define the mgt share equity

Maximum of what is left after all providers of finance, also seen as the minimum required to incentivise mgt to deliver business plan

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Who is the source of finance?

PE firms, they use loans from banks. Mgt team expected to give as much as possible before financing.

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Describe the model of the MBO

Close partnership and trust between mgt team and investors. Financial structured carefully tailored to generate cash & profits. Mgt and investors share clear objectives. Ownership structures provide motivation for mgt.

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Name 3 approaches to boost value of investment

Financial engineering approach, Enhance earnings approach, multiple arbitrage approach

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Describe the Financial engineering approach

Use the cash generated from businesses to repay debt. As debt is repaid, equity value increase. This approach require tight focus on cash covering debt interest and principal payments.

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When would you use the Financial engineering approach

Low interest rates, the company is stable, competition is limited

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Describe the Enhanced Earnings approach

Grow profits by increasing revenue or cutting cost. Increases in profit can be used to pay off debt. Additional profit can also be used to pay dividends to equity holders.

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When would you use the Enhance Earnings approach

Poor management, in a growth sector

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Describe the Multiple Arbitrage approach

Buying company in distressed conditions, sell in upturn. Requires M&A skills to persuade buyer to pay higher multiple than original investment.

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When would you use the Multiple Arbitrage approach?

When markets are rising.

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What operational improvements can be done to create value?

Have a smaller working capital. Have a better location to operate where its cheaper and efficient. Outsource production of non-core processes to save money

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What growth initiatives can be used to grow value?

Strengthening of sales organisation. Increased marketing budget. Development of new produts/services. Stronger export orientation

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Describe an LBO

SPV created to make acquisition. Capital provided by PE firm and mgt. Bank finance used to part fund acquisition and provide working capital. Security is target's assets. Funding only commited when acquisition takes place.

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Types of debt

Senior, Mezzanine, High yield debt, Institutional debt

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Describe Senior debt

Senior lenders have priority of interest and principal payments. Lenders receive lowest interest. Debt is secured over all assets of borrower.

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Describe mezzanine debt

Subordinated to senior debt. Part of interest is paid in cash while other part is rolled up in principal. It provides warranty/option to purchase equity shares from borrower at nominal price.

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Describe High yield debt

Bond/notes sold to investors through publicly traded market. Referred to as Junk bonds. Interest is paid semi-annually. Has penalties for early reayment of debt.

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Describe Institutional debt

non-bank lenders providing capital to small and medium size companies in the form of loan rather than equity. Integral part of equity structure but structured as debt rather than shares. On exit, bulk of equity investor are repayable first before mgt

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Name the 3 MBO investment criteria for PE

Strategy, Company, Managment team.

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Describe Strategy criteria

Does target have defensible market position? Do they have a dominance presence in the market? Is there a clear exit route?

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Describe the Company criteria

Must have profits which can be converted to cash. Need good history of sales and profit growth. Have a cost control culture. Must be independently viable.

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Describe the management team criteria

Must be able to operate independently. Must have strategic awareness. Must share clear objectives with investors. Must be financially sophisticated.

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Management Buy Outs

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