Question

Question 3:

What are some of the motivations for leveraged and management buyouts of the firm?

Answer 1

In a leveraged buyout (LBO) a company is purchased with a combination of equity and debt, such that the company's cash flow is the collateral used to secure and repay the borrowed money. Usage of large debt lowers the overall cost of acquisition as the cost of debt is usually lower than that of equity. Management buyouts (MBO) are usually a variant of LBOs where a company’s management team purchases the assets and operations of the business.

Some of the motivations for leveraged buyouts (LBO) and management buyouts (MBO) are:

1. To take a public company private: In the case of publicly traded companies, an LBO or MBO would result in shares being bought back from the public and the company becoming private, with ownership now resing with few people or entities involved in the buyout.
2. To transfer private property, as is the case with a change in small business ownership.
3. To spin-off a portion of an existing business by selling it: In such cases, the LBO or MBO is performed on a division of the company rather than the whole company, resulting in a spin-off (i.e. a new company from a division).
4. MBOs give greater potential rewards to the management by giving them control of the organization
5. In the case of MBOs, the intention of the existing owners is to exist in the business whereas the existing management team sees a good future in the business. Thus by the MBO, the motivations of both parties can complement each other and the companies operations keep going. Selling the company to the existing management team is preferred in such a case rather than selling the company to external new entities.