The Routledge Companion to Management Buyouts

Mike Wright, Kevin Amess, Nick Bacon, Donald Siegel, Mike Wright, Kevin Amess, Nick Bacon, Donald Siegel

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351862523
• Edition: 1
• Topic: Business
• Subtopic: Business generale
• Index: Business

Management Buyouts (MBOs) first came to prominence in the US during the early 1980s, and have subsequently become a global phenomenon and a highly significant transaction within the corporate restructuring landscape

Although much recent attention has focused on private equity (PE) backed buyouts, these are only a subset of the total MBO market. The Routledge Companion to Management Buyouts takes a much broader definition, reviewing the current state of research and theory and where further developments are likely to occur and incorporating PE and non-PE backed buyouts, as well as variations such as management buy-ins and management-employee buyouts. It goes beyond the purely financial perspective, exploring the many different aspects of management buyouts and incorporating related disciplines including strategy, organizational change, and HRM providing the first truly comprehensive authoritative resource on the topic.

Expertly edited, and drawing on international scholarship, this unique volume will be an invaluable sourcebook on MBOs for researchers and advanced students as well as those interested in the broader areas of corporate restructuring and ownership change.

11

MANAGEMENT BUYOUTS

An introduction and overview

Mike Wright, Kevin Amess, Nick Bacon, and Donald Siegel

Introduction

Management buyouts (MBOs) are part of a family of related forms of transactions where a firm is transferred to a new set of owners, among which senior managers become significant equity holders. To some extent, MBOs are not new. Buyouts of sleeping partners by mill owners and private placements of listed corporations have been consummated for over a century (Wright et al., 2000; Toms & Wright, 2002). What is relatively new is the growth of the phenomenon and the role of specialist equity and debt providers since the late 1980s. As a result, from being a peripheral intellectual curiosity, private equity (PE) and MBOs have become a major part of the overall market for corporate control.

From the initial emergence of the MBO in the US corporate restructuring landscape, MBOs have been controversial. Iconic early first wave examples of MBOs, such as Safeway and RJR Nabisco, were closely associated with improving firm efficiency through reducing agency costs, restructuring, cost-cutting, divestments, employment reductions, etc. and were often portrayed in the public media and in polemics such as “Barbarians at the Gate” (Burrough & Helyar, 1989) and “Stiffed” (Faludi, 1999). This perspective was carried through into the second wave with deals such as Grohe in Germany and the AA and Birds Eye in the UK paraded variously as locusts, casino capitalists, “strippers and flippers” (i.e., stripping assets and exiting in the short term), and the like (Bacon et al., 2013). Bruner and Paine (1988) noted that critics of MBOs were concerned that such highly leveraged transactions could threaten financial stability in the US, the financial restructuring creates no real economic benefit, and managers involved in an MBO suffer a conflict of interest because of managers’ fiduciary duty to shareholders.

While the lurid portrayal of buyouts has provided a convenient caricature to whip up media frenzy by critics of PE and buyouts, it has always been a partial view of the market. Academic evidence suggests that incumbent managers involved in an MBO do not exploit their insider information position (Lee, 1992). In practice, a key issue for managers is to establish “mitigation measures” in order to avoid a breach of fiduciary duties. This involves declaring an interest and ensuring they have no involvement in the decision to sell and negotiate on behalf of owners.

Oftentimes the critical perspective has itself been short termist, and some of the critics’ causes célèbres have turned out not to be as they have been portrayed (Wood & Wright, 22010). For example, Grohe demonstrated significant growth post buyout. Although Birds Eye had been slated for closure by its parent Unilever before the buyout, performance improved in five consecutive years following the buyout (Leyland, 2012).

Many buyouts, such as Unipart, Istel, and DPCE in the UK (Wright & Coyne, 1985/2018) and Seagate Technology (Loihl & Wright, 2002) and Duracell in the US (Wright et al., 2001), in fact pursued significant entrepreneurial and innovative trajectories. Other examples have seen managers expressing themselves, like those in Freedom Securities which became free at last from the constraints of their parent John Hancock that prevented them from pursuing growth opportunities (Wright et al., 2001).

Concern about MBOs’ impact on financial stability has also been intermittently debated over time. For instance, the Bank of England (2013) has expressed concerns about high leverage during times of exuberance. Long-standing and continuing areas of debate surround the returns on investing in PE funds, the drivers of MBO activity, and the real economic consequences of MBOs.

The aim of this book is to bring together a wide range of systematic evidence from a variety of disciplines in order to form an overall assessment of the development and impact of PE and MBOs. In this introductory chapter, we begin by providing an overview of the variety and trends in MBO types or organization. This is followed by an outline of the theoretical perspectives that have been advanced to explain buyouts. Next, we summarize the contributions of each of the chapters comprising this volume before synthesizing the essence of the insights provided by the large body of evidence now available. Finally, we make some general comments regarding the future prospects for MBOs and PE.

Variety

A Leveraged Buyout (LBO) involves the transfer of a whole company or part of a company to new owners using high levels of debt to help finance the transaction secured against the firm’s assets and/or future cash flows (Thompson & Wright, 1995; Kaplan & Strömberg, 2009).

The term Management Buyout (MBO) is used to define those buyout transactions where serving managers acquire a significant ownership stake. Management Buy-In (MBI) is the term used to define a transaction where outside managers acquire a significant ownership stake (Thompson & Wright, 1995). Another key distinction is between those transactions with backing from PE firms and those without PE-backing. PE firms may or may not take a majority equity stake in the portfolio company. Where PE firms lead the transaction and become the majority owners, these are termed investor-led buyouts (IBOs).

PE firms establish limited life funds (typically about 10 years in duration) to raise capital for the purpose of acquiring a portfolio of existing firms via an LBO. The PE funds are usually established as limited partnerships and there are two types of fund partners: limited partners (LPs) and general partners (GPs). The LPs provide most of a fund’s cash and its investors include: wealthy individuals, pension funds, investment banks, and insurance companies. LPs have little say in how the funds are invested, although they may use covenants outlining some broad conditions under which the cash is invested (e.g.,, the proportion of a fund invested in a single deal). GPs in a PE firm manage funds, which involves selecting firms for a buyout deal, structuring its finances, negotiating the deal, and being a representative on portfolio firms’ boards of directors. Returns to investors are generated by improving firm performance, making these companies more valuable, and then achieving a capital gain from selling the portfolio firm (i.e., exiting the investment).

3Trends

The years since the 1980s have been marked by two major waves of buyouts. Following initial growth from the late 1970s, the first major growth in the market occurred in the second half of the 1980s with a first peak in 1989 (Figure 1.1).

Following the recession of the early 1990s, which saw a collapse in market value but a growth in buyouts of distressed firms, the market recovered during the rest of that decade (CMBOR, 2018). Fall-out from the bursting of the dot.com bubble meant that the PE market went into reverse for a couple of years around the turn of the millennium before resurging to reach a second, larger peak in 2007.

Figure 1.1 Entry and exit values for PE-backed buyouts in Europe

Source: CMBOR/Equistone Partners Europe/Investec Bank.

Figure 1.2 Vendor sources of PE-backed buyouts in Europe

Source: CMBOR/Equistone Partners Europe/Investec Bank.

4After reaching a nadir in 2009, the market again recovered with PE fund raising continuing at high levels. At the time of writing, market value was heading towards new peaks driven by a relatively small number of larger deals against a backdrop of a sharp decline in deal volume.

The evolution of the market has been marked by a number of shifts in the composition and funding of deals over time. Vendor sources of deals have shifted from a dominance of buyouts of divisions of larger groups in the first wave (CMBOR, 1990) to a more diverse picture in which secondary buyouts (SBOs) are now marginally ahead of primary deals in value terms. Secondary buyouts involve the acquisition of an initial buyout by a new set of PE and management investors, with the initial investors exiting either fully or partially (Figure 1.2).

In the first wave of buyouts, smaller MBOs predominantly of family firms and divisions of larger groups predominated. In the second wave, this picture changed dramatically with much lower volumes of these kinds of deals and a growth in larger MBIs and investor-led buyouts (Figure 1.3).

Figure 1.3 From MBOs to MBIs in Europe

Source: CMBOR/Equistone Partners Europe/Investec Bank.

5Since the late 1980s, the MBO market has significantly expanded worldwide. In the European context, the overwhelming dominance that the UK had from the 1980s has gradually been eroded as other countries’ markets have grown (Figure 1.4). While the UK market remains the largest, the German and French markets are also strong (CMBOR, 2018).

Figure 1.4 European PE-backed buyout markets

Source: CMBOR/Equistone Partners Europe/Investec Bank.

6As the market has grown in terms of new deals being completed, so too has the number of existing deals looking for an exit to enable investors to realize their gains. Macroeconomic recovery after the financial recession meant a release of the pent-up demand for realizations, such that for the first time the value of exits has in recent years exceeded the value of new deals (Figure 1.1). The forms of exit have also changed over time, with fewer IPO exits and a marked increase in SBOs as an exit route, such that SBO value has recently exceeded primary buyout value (Figure 1.5).

Figure 1.5 Exit routes of European PE-backed buyouts

Source: CMBOR/Equistone Partners Europe/Investec Bank.

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Figure 1.6 Deal financing structures: UK deals above £10 million transaction value

Source: CMBOR/Equistone Partners Europe/Investec Bank.

Financing structures have also changed over time. The average amount of leverage in deals rose through the 1980s during the first buyout wave before falling back during the recession of the early 1990s (CMBOR, 1993). Based on UK data, the impact of the financial crisis that halted the second buyout wave was starkly demonstrated as the average percentage of senior debt in buyouts with a transaction value above £10 million fell from 52% in 2006 to a low of 27% in 2011 (Figure 1.6). Since then there has been something of a recovery but not yet back to pre-financial crisis levels. By the end of 2017, the average senior debt in deals with a transaction value above £10million stood at 48%.

The chapters by Gilligan and Toms in this volume analyze the drivers of these trends in more detail.

Theories

Agency

From an academic perspective MBOs have been largely viewed through three theoretical perspectives: agency theory, behavioral theory, and an entrepreneurial perspective. Historically, agency theory has dominated our theoretical understanding of MBOs. Jensen’s (1986) seminal work is pivotal in framing MBOs as a restructuring transaction that improves firms’ corporate governance and remedies the agency costs associated with the publicly listed corporation.

Managers are the agents of firms’ shareholders and have a fiduciary duty to manage firms’ resources in shareholders’ best interests, i.e., to maximize firm value. Managers, however, might not always act in shareholders’ best interests because they have discretion in the use of firms’ resources and so could pursue other objectives for their own private benefit (Jensen & Meckling, 1976). Executive remuneration contracts and the board of directors are internal 8governance devices seeking to align managers to the objective of maximizing firm value. Doubts remain, however, as to their effectiveness (Bebchuk & Fried, 2006). Jensen (1986) argues that agency costs associated with managers’ discretionary behavior are most severe in firms that generate free cash flow, which is cash in excess of that required to fund all a firm’s profitable projects. This is because managers will waste cash (e.g.,, on unprofitable capital expenditures) from which they obtain private benefit but destroy shareholder value. These firms underperform and become potential targets for an MBO (Fox & Marcus, 1992).

The MBO governance structure has three features that reduce agency costs (Jensen, 1986; Thompson & Wright, 1995; Kaplan & Strömberg, 2009). First, managers’ significant equity stake after a buyout unifies management and ownership roles, creating financial incentives to value-maximize and not waste cash on unprofitable projects. Second, the interest payments on debt require servicing, which encourages managers not to waste cash and motivates managers to generate cash to service the debt. Finally, PE firms have a significant equity stake in their portfolio firms and are therefore financially motivated to be active investors. They normally have board representation and sometimes have a representative as Chair. Theory predicts that improved governance installed after an MBO results in improved performance.

Behavioral

Behavioral approaches to understanding the motivation for MBOs provide competing arguments to those offered by an agency perspective (Fox & Marcus, 1992). Some arguments suggest that an MBO is a response to takeover threat. First, managers in underperforming firms that are targeted for a takeover will likely lose their jobs (Franks & Mayer, 1996). Therefore, incumbent managers might undertake an MBO in order to protect their jobs and to avoid being associated with failure. If underperforming managers are using an MBO to protect their own positions, we would expect to observe continued underperformance after an MBO. Such deals would only be financed if there are imperfections in the capital market with financial backers not conducting sufficient due diligence. Second, managers might want to protect their jobs because they possess human capital that is highly firm-specific and their next best job will pay a lower wage. If a takeover threatens...