Why an early buyout may be profitable for your business
For many entrepreneurs, it is always very difficult to let go. They mostly are sentimental about it; to give up the business they had grown and nurtured might seem too hard of a thing to do. But sometimes it may be best to let go, or share ownership with another party. This is always too much to bear for the entrepreneur, but sometimes it is the best option. Especially when an early buyout offer is received. I am sure you would be asking yourself what a buyout is? .. Let me break it down for you.
A buyout is the purchase of majority holdings of a company’s shares by another company. The acquirer gains controlling interest of the target firm. Majority shares mean more than 50% holding of shares are held by one single entity or individual. With this, controlling interest is obtained and the acquirer can choose to make the company acquired its subsidiary, merge it with another business, or divest it and sell off its assets. When this happens, the original owner has no right to stop this because he has already sold his interest. In other words, he has no control over what the new owners may decide to do to the business.
Types of buyouts
- Management buyout: In management buyout, the management team purchases the assets and operations of the business they manage. The management are the people that run the business so they have first hand information on the operations of the business. They may even know more about the business than the original business owners. This then is a concern because management may possess asymmetric information and it may offer unfair advantage relative to the current owners. This is because the management might have seen the prospects of the business in the long term and know that if an attractive bid is put out and it is bought, the returns in the nearest future would greatly surpass the acquisition cost.
Management buyout can also occur as a last resort to save a company from permanent closure, or replacing the existing management team by an outside company.
- Management buy-in: A management buy-in occurs when a management team from outside the company acquires the company by purchasing the assets and operations of the business, and they inevitably replace the existing management. Private equity and hedge funds are examples of management teams that practice the management buy –in. If the company is seen to be undervalued and fits their investment criteria; after some due diligence, they would acquire the company and make it private, use their management expertise and /or bring in a management team they feel would manage it better than their predecessors.Why they (private equity funds & hedge funds) do it is to unlock value, maximize gains , and bring high returns to their portfolios.
- Leveraged buy out: A leveraged buyout is the acquisition of another company using a significant amount of borrowed money which is termed debt. It is not totally debt as some equity may be involved; but the ratio is usually 90 : 10 (debt : equity). So basically an acquirer takes loans to finance the purchase of another company, and the collateral used may be the assets of the company to be acquired and also the assets of the acquirer. A leveraged buyout is very risky and credit ratings on the company would fall into non-investment grade or junk bonds. This is because of the high leverage ratio. Interests are to be paid on the money borrowed. The money is usually very large, so is the interest and the operating cash flows; and the company may be unable to settle its obligations
So an early buyout may occur not long after the company starts operating. This is because outsiders may have seen the potentials of the business and may want to quickly snatch it before competitors do or before the value escalates. The value escalating might be because of a strategy they have. So an early buyout might actually be a win – win situation. This is because an early buy out may be mispriced. The company looking to acquire your business may be looking to persuade you by all means because of the rare gem they have seen in your business. So they give you ridiculously high amounts. Also they may have more experience running the business and actually lead it to greater heights than if it were you running it; this is why I say it is a win-win situation.
An early buyout can also provide a business owner with enough money to start another highly profitable business venture and also consult occasionally for his former business in case the acquirers needs his help or expertise.
Steven Rogers., Roza Makonnen., Entrepreneurial Finance