Management Buyout (MBO)
What it is:
A management buyout (MBO) occurs when the current management of a company acquires a controlling interest or the entire interest in a company from existing shareholders.
How it works/Example:
For example, Company XYZ is a publicly traded company where management controls 30% the company's stock and the remaining 70% is stock floated to the public. Under the terms of an MBO, management will arrange to purchase enough shares of the outstanding stock from the public so that they end up with a controlling interest of at least 51% of the company's total shares.
In order to finance their venture, the management group may look to a bank or venture capitalists to assist them in financing the acquisition.
Why it matters:
The primary difference between a management buyout and any other type of acquisition is the inherent knowledge and expertise of the buyers compared with the sellers. The buyers (management) will usually have more knowledge of the company and its prospects than the sellers. In most scenarios, the sellers rely on the input of management regarding the future of the company to help set the selling price. Here, the advisors become the buyers. In this scenario, the sellers are at a clear disadvantage.
For instance, the management, as buyers, may exploit their advantageous position by manipulating the stock price through certain types of stock sales so that they will achieve a lower buying price. They may also try to lower the purchase price of the company by taking aggressive write-offs in order to show less net income in the period leading up to the purchase. The sellers therefore must use caution with regard to the buyers in an MBO.
Likewise, the management as buyers must also exercise caution with regard to the financiers they bring to assist with the purchase. Venture capitalists, for example, may have different goals than the company’s management team regarding the expected timing and nature of the return on investment (ROI) in the company. In a case where a venture capitalist investor has gained a large enough stake in an MBO, the management who purchased the company may have less control over how to actually manage the company.