Private equity buyout funds make up the largest segment of private market strategies. Buyout managers aim to take a controlling stake in mature businesses with the intention to improve the business and exit at a higher multiple.
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Buyouts in a nutshell
- Target companies. Buyout managers typically target mature businesses with the aim of implementing changes to improve revenues and exit opportunities.
- Typical investment type. Buyout funds generally make large investments (>$100m) to purchase controlling stakes in companies with the intention of improving the business and exiting at a higher multiple.
- Value add operations. Buyout managers look to add value typically by improving revenue growth, optimising costs and efficiency, making leadership changes or using leverage.
- Exit strategies. Typical exits are by way of a strategic sale or an IPO.
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What is a buyout fund?
Buyout funds look to purchase controlling stakes in companies with the intention to improve the business and exit at a higher multiple. Target companies are usually mature businesses with established cash flows and hard assets.
Typically, up to 75% leverage used in transactions with company assets and future cash flow used as collateral, hence the alternative name “leveraged buyout”. See ‘Why “leveraged” buyout? for more on how this works.
A buyout manager’s ability to identify long term macroeconomic trends - as well as individual target companies - is key to strong performance. Valuation of each target company is carried out by incorporating comparable valuations, debt levels as well as the potential future exit value.
The main exit avenues for buyout funds are by way of a strategic sale or an IPO. See Private Equity Harvesting Stage for more.
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What is a “minority buyout” fund?
“Minority buyout” funds follow a similar strategy to buyout funds, but only purchase minority stakes in target companies. Since they are not in full control of the company, they often require board seats to help guide the company’s growth from within. As such, they can be seen as a cross between a buyout and growth equity fund.
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How do buyout managers add value?
Sourcing proprietary deals: Buyout managers will leverage their network of entrepreneurs and portfolio companies to source unique deals. The ability to source and construct complex deals is a competitive advantage for more experienced managers.
Revenue growth: Often referred to as “topline growth”, a buyout manager will use their controlling position to optimise pricing, enter new geographies and refocus product development.
Improving margins: Buyout managers often implement cost-optimisation programs, improve supply chain practices and eliminate redundant costs or assets. They can also optimise the capital structure of a business by increasing or decreasing leverage levels.
Focusing on core activities: This involves strategic redirection - exiting non-core activities to focus on primary activities. Whether the changes affect product and service lines, geographic focus or otherwise, the aim is similar to above: to grow revenue and improve margins.
Enhancing management: Buyout managers can also leverage their networks to complement existing leadership - whether positioning a new CEO or simply building out the broader management team.
Exit planning: A buyout manager will advise portfolio companies on potential exit avenues through an IPO, strategic sale or secondary buyout.
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Why “leveraged” buyout?
The term “leveraged buyout” has lost popularity over recent years, but the use of leverage is still a key driver of returns. It works like this:
- At acquisition: If a deal is funded by a mixture of equity and debt - using the target company’s cash flow as collateral - then it lowers the cost at acquisition.
- During ownership: Interest payments (from debt) lower the tax rate throughout ownership, while dividend payments (from equity) do not.
- Overall, the cost of financing is reduced when a deal is funded with debt, which acts as a lever to increase returns - hence “leverage”.
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Important notice: This content is for informational purposes only. Moonfare does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorised advisor. Past performance is not a reliable guide to future returns. Don’t invest unless you’re prepared to lose all the money you invest. Private equity is a high-risk investment and you are unlikely to be protected if something goes wrong. Subject to eligibility. Please see https://www.moonfare.com/disclaimers.
FAQs
Buyout managers look to add value typically by improving revenue growth, optimising costs and efficiency, making leadership changes or using leverage. Exit strategies. Typical exits are by way of a strategic sale or an IPO.
How do buyouts create value? ›
Value creation in buyout funds
It derives directly from the ability of fund managers to add value to the companies they invest in, generating returns through an active approach to investment and management.
What are the different buyout strategies? ›
Take-private, corporate carve-out, buy & build, and distressed-for-control are great buyout strategies. While they offer superior returns, there are plenty of deals that just don't fall into these categories. Another way for private equity firms to achieve superior returns is to specialize in a particular sector.
How do investors of a buy-out fund earn their return? ›
Buyout funds are the most common form of private equity. They typically invest by taking a controlling stake in privately-held companies, working to improve the operational efficiency and profitability of these businesses, so as to enhance the return on investment when the stake is sold.
What is the difference between a buyout fund and a growth fund? ›
Growth equity funds target companies that have potential for scalable and renewed growth. Unlike buyout funds, they usually take a minority stake with the intention of growing the business as much as possible. But - like buyout funds - the goal is to exit at a higher multiple. Target companies.
How do you value a buyout? ›
Calculating the Buyout Amount
Once the equity stake is determined and the business is valued, the buyout amount can be calculated. This involves multiplying the partner's equity by the business value, which is a crucial step in the partnership buyout process when you decide to buy out a business.
How do acquisitions add value? ›
A careful selection of targets and effectively implemented acquisitions can achieve synergy and create value. For example, the difference in sizes between the acquiring company and the target company influences value creation.
How do buyout funds work? ›
What is a buyout fund? Buyout funds look to purchase controlling stakes in companies with the intention to improve the business and exit at a higher multiple. Target companies are usually mature businesses with established cash flows and hard assets.
How do you structure a buyout deal? ›
The terms you will want to identify and explore include the following:
- Involved parties.
- Valuation of the company in question.
- Buyer funding options.
- Withdrawal events.
- Purchasing rights to departing owner's interest.
- Valuation of said interest.
- Payment terms.
- Tax obligations.
The management buyout process typically follows a series of steps that include:
- Step 1: Performing a company analysis.
- Step 2: Negotiating a company's selling price.
- Step 3: Financing the buyout.
- Step 4: Creating a transition plan.
- Step 5: Transferring ownership, knowledge, and capabilities to new management.
The term management buyout (MBO) refers to a financial transaction where someone from corporate management or the team purchases the business from the owner(s). Management members that execute MBOs purchase everything associated with the business.
What are the motivations for buyouts? ›
The key motive behind any buyout is the same as that which should drive all acquisitions: value generation. The buyer or buyers recognize the potential for value creation by taking a majority control of the company in question.
What are the advantages of buyout? ›
Advantages of Buyouts
A buyout may get rid of any areas of service or product duplication in businesses. It can reduce operational expenses, which in turn can lead to an increase in profits. The business taking part in the buyout can do a comparison of individual processes and select the one that is better.
What is the difference between venture capital and buyout funds? ›
As such, venture capital funds often take minority stakes (current shareholders dilute when the VC comes in) whereas buyout funds make majority investments (often buying out the majority of current shareholders).
What is the difference between management buyout and leveraged buyout? ›
A leveraged buyout (LBO) is when a company is purchased using a combination of debt and equity, wherein the cash flow of the business is the collateral used to secure and repay the loan. A management buyout (MBO) is a form of LBO, when the existing management of a business purchase it from its current owners.
How do you know if a fund is growth or value? ›
Growth stocks are those of companies that are considered to have the potential to outperform the overall market over time because of their future potential. Value stocks are classified as companies that are currently trading below what they are really worth and will thus provide a superior return.
What is the purpose of a buyout? ›
A buyout involves the process of gaining a controlling interest in another company, either through outright purchase or by obtaining a controlling equity interest. Buyouts typically occur because the acquirer has confidence that the assets of a company are undervalued.
How does an LBO create value? ›
The returns in an LBO are driven by three factors, which we demonstrate in our topic on creating value in LBOs: De-levering (paying down debt) Operational improvement (e.g. margin expansion, revenue growth) Multiple expansion (buying low and selling high)
Why do companies offer buyouts? ›
Employee buyouts are used to reduce employee headcount and, thus, salary costs, the cost of benefits, and any contributions by the company to retirement plans. A common formula for severance packages includes a base of four weeks pay plus an additional week for every year of employment at the company.
What is the source of value creation in merger? ›
More than 90% of value created in mergers comes from earnings synergies and the difference between cost of capital of the combined firm and the acquirer.
