M&A Vocabulary – Understanding the experts: “MBO, MBI, LBO”

In times of global uncertainty factors such as pandemics, armed conflicts, increased logistics risks and rising economic tensions, a number of companies are considering divesting (unprofitable) parts of their corporate group or selling only slightly profitable business units to generate liquidity reserves.

However, since investors are also confronted with the uncertainties mentioned above, it can be crucial how familiar a potential buyer is with the risks, but also the opportunities, that an acquisition creates for the target company. Since the management of the “target company” has the most immediate information and the best overview of this topic, an acquisition of the company directly by members of the executive management and, if applicable, other senior employees can be a viable alternative to an acquisition by a strategic or financial investor.

Such a management buyout (MBO for short) generally follows similar process steps to a classic transaction; however, the requirements for due diligence are usually significantly lower, as management as the buyer generally has more information available than the seller. In addition, as a rule the seller will not provide covenants or reps and warranties to the extent typically expected.

Therefore, key questions in such an MBO are, first, preparing an appropriate valuation of the acquisition object, since a selling shareholder will typically have the detailed information for the Purchase Price Calculation prepared by the target company’s management—something that is only possible to a limited extent here due to the existing conflict of interest. Second, the financing of the purchase price must be clarified, since in very few cases do the members of management, even if they pool their financial resources, have sufficient funds to acquire the target company. For this reason, an MBO is also regarded as a sub-type of a leveraged buyout (LBO for short), i.e., a transaction realized with substantial use of funds provided by third-party financiers. In addition to banks—which often hesitate to finance such MBOs due to strict risk management requirements—these are frequently mezzanine capital providers, private equity, or even venture capital investors.

To avoid making the deal structure overly complex, the members of management establish a joint company that acquires the target company directly or—especially where private equity investors are involved to finance the acquisition—set up an acquisition vehicle together with the financier through which the target company is acquired. Depending on the financing structure, this may subsequently result in a debt push down.

Another variant of acquiring a company by members of a management team—who generally consider themselves better suited to make the company profitable or more profitable than the existing shareholder—is a management buy-in (“MBI” for short). Unlike an MBO, the buyers in an MBI are not the internal, existing management and its members who run the target company at the time of acquisition, but an external team of managers who, as part of the transaction, replaces the existing management. Especially if this team can already look back on a number of successful acquisitions in which the acquired companies, after restructuring, were sold at a profit to a strategic investor or perhaps even taken public, external capital providers can be won more easily for transaction financing than in an MBO, whose participants may have expertise but may also have contributed to the target company’s low profitability at the time of the transaction.

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