What is a Management Buyout (MBO)?
A Management Buyout (MBO) is a leveraged buyout transaction structure in which a significant portion of the post-LBO equity contribution comes from the prior management team.
Management Buyout (MBO) Transaction Structure
Management buyouts are transactions where the management team is actively involved in the partial or full acquisition of the company they currently manage.
The financing source of an MBO transaction – similar to a traditional LBO – is a combination of debt and equity in the post-LBO capital structure.
The sources of funding are usually obtained from the following:
- Senior Debt Lenders → e.g. Traditional Banks, Institutional Investors, Direct Lenders
- Subordinated Debt Lenders → e.g. Mezzanine Debt, Hybrid Financing Instruments
- Equity Contributions → e.g. Financial Sponsor Contribution, Rollover Equity
From the perspective of the financial sponsor, the rollover equity by management is a “source” of funds that reduce:
- Debt Financing → The total amount of debt funding needed to be raised
- Equity Contribution → The equity contribution by the private equity firm
MBO Transaction Process
If a management team decides to rollover part of its equity into the new post-LBO entity, it is generally because they are under the belief that the risk undertaken by participating is worth the potential upside.
In the case of an MBO, it is the management that is most often the one initiating the discussions surrounding a take-private with private equity firms and lenders.
The catalyst for a management buyout (MBO) is more often than not an unhappy management team.
After receiving criticism under current ownership or due to being a publicly traded company, the management team can decide the company could be run better under their guidance (and without external distractions such as constant pressure from shareholders or negative press coverage).
Hence, management buyouts coincide with lackluster performance, negative investor sentiment, and scrutiny from the shareholder base (and the general public) in practically all cases.
In an MBO, management is essentially taking over the company that they manage, which sounds contradictory but implies management has lost control over the company and its current trajectory.
Therefore, the management team seeks the support of institutional equity investors, namely private equity firms, to complete a transaction and acquire the company.
Management Buyout (MBO) vs. Leveraged Buyout (LBO)
A management buyout (MBO) is a type of leveraged buyout (LBO) transaction, but the key differentiating factor is the active involvement of management.
In an MBO, the transaction is led by the management team, meaning that they are the ones pushing for the buyout (and seeking outside financing and support) and the ones most convinced that they can create far more value as a private company.
The active role of management is a positive signal to the other equity investors backing the buyout, as the incentives of management and other investors become naturally aligned.
By contributing a significant portion of their equity via an equity rollover – i.e. existing equity in the pre-LBO company is rolled over into the post-LBO entity – management effectively has “skin in the game”.
Equity contributions represent arguably the best incentive for management to strive for outperformance, especially if new cash is also contributed.
Not to mention, management buyouts (MBOs) of public companies tend to receive significant media coverage, so management is putting their reputation on the line, i.e. management’s decision to take over the company signals their belief that they can run their company better than anyone else out there.
MBO Example – Michael Dell and Silver Lake
An example of a management buyout (MBO) is the privatization of Dell in 2013.
Michael Dell, the founder, chairman, and CEO of Dell, took the company private in partnership with Silver Lake, a global technology-oriented private equity firm.
The buyout was estimated to be worth $24.4 billion, with the take-private rationale per Michael Dell being that he could now exert more control over the direction of the company.
Because Dell is no longer publicly-traded, the company can operate without concerns about constant scrutiny from shareholders or negative media coverage, especially from activist investors, namely Carl Icahn.
As with most MBOs, the transaction occurred following underperformance by Dell, which was largely attributable to slowing PC sales.
Since being taken private, Dell has been revitalized and evolved into a top information technology (IT) company – and is once again publicly traded after a complex arrangement with VMware – with a strategy now based on becoming more diversified and using strategic acquisitions to offer a more complete suite of products in verticals such as enterprise software, cloud computing, gaming, and data storage.
Michael Dell Open Letter to Shareholders (Source: Dell)