What Is a Buyout?

What Is a Buyout?

Let me explain what a buyout is: it's the acquisition of a controlling interest in a company, and you can use it synonymously with the term acquisition. If the stake is bought by the firm’s management, I call it a management buyout, and if high levels of debt fund the buyout, it's known as a leveraged buyout. You'll often see buyouts happen when a company is going private.

Key Takeaways

Remember, a buyout means acquiring a controlling interest in a company, just like an acquisition. When the firm’s management buys the stake, it's a management buyout, and when high debt levels fund it, it's a leveraged buyout. These buyouts frequently occur as companies transition to private ownership.

Understanding Buyouts

Buyouts happen when a buyer acquires more than 50% of the company, which leads to a change in control. Firms that specialize in funding and facilitating these buyouts act alone or together on deals, and they usually get financed by institutional investors, wealthy individuals, or loans.

In private equity, funds and investors look for underperforming or undervalued companies that they can take private, turn around, and then take public again years later. Buyout firms get involved in management buyouts, where the management of the company being purchased takes a stake. They often play key roles in leveraged buyouts, which are funded with borrowed money.

Many partnerships include clauses like buy-sell agreements or shotgun clauses that can force other partners to agree to buying out an offering partner or even force them to sell their shares.

Sometimes, a buyout firm believes it can provide more value to a company’s shareholders than the existing management does.

Types of Buyouts

Management buyouts, or MBOs, provide an exit strategy for large corporations that want to sell off divisions not part of their core business, or for private businesses whose owners wish to retire. The financing for an MBO is often substantial, usually a mix of debt and equity from buyers, financiers, and sometimes the seller.

Leveraged buyouts, or LBOs, use significant borrowed money, with the assets of the acquired company often serving as collateral for the loans. The company doing the LBO might provide only 10% of the capital, with the rest coming from debt. This is a high-risk, high-reward approach, where the acquisition needs high returns and cash flows to pay the debt interest. The target company's assets are typically collateral, and buyout firms sometimes sell parts of it to pay down the debt.

Examples of Buyouts

In 1986, Safeway's board of directors avoided hostile takeovers from Herbert and Robert Haft of Dart Drug by allowing Kohlberg Kravis Roberts to complete a friendly LBO of Safeway for $5.5 billion. Safeway then divested some assets and closed unprofitable stores. After improving revenues and profitability, Safeway went public again in 1990, and Roberts earned almost $7.2 billion on his initial $129 million investment.

In another case, in 2007, Blackstone Group bought Hilton Hotels for $26 billion through an LBO. Blackstone put up $5.5 billion in cash and financed $20.5 billion in debt. Before the 2009 financial crisis, Hilton faced declining cash flows and revenues, but it later refinanced at lower interest rates and improved operations. Blackstone sold Hilton for a profit of almost $10 billion.