Leveraged and Management Buyouts

There are various options available for the revival of a ‘sick company. One is buyout of such a company by its employees. This option has distinct advantages over Government intervention and other conventional remedies. Buyout by employees provides a strong incentive to the employees in the form of personal stake in the company. The employees become the owners of the company by virtue of the shares that are issued and allotted to them. Moreover, continuity of job is the greatest motivating force which keeps them on their toes to ensure that the buyout succeeds. Such a buyout saves mass unemployment and unrest among the working class. Relations between the worker management and the employees are expected to be cordial without any break, strike or other such disturbing developments. Hence chances of success are more. However, such a buyout can be successful only if necessary financial support is extended by the Government or the financial institutions and banks.

In Navnit R. Kamaniv. R.R. Kamani, two schemes of rehabilitation came before the Board for Industrial and Financial Reconstruction (BIFR) for consideration and approval. One of the schemes was presented by a shareholder holding 24% shares in the company and the other scheme was submitted by the workmen’s union of the company. When the two schemes were viewed in juxta-position, there was no doubt that the scheme presented by the applicant shareholder appeared in a rather poor light. The BIFR sanctioned the scheme which was presented by the workers’ union because, in the opinion of the BIFR, that scheme was more suited for the revival of the company.

The matter went to the Supreme Court. Turning to the merits of the scheme presented by the workers and sanctioned by BIFR, it was considered to be feasible and economically viable by experts. It envisaged the management by a Board of directors consisting of fully qualified experts and representatives of banks, Government and of the employees. The scheme had the full backing of the nationalized banks and the encouragement from the Central and State Governments which had made commitments for granting tax concessions. The backing and the concessions were forthcoming essentially because it was a scheme framed by the employees who themselves were making tremendous wage-sacrifice and trying to salvage the company which has been almost wrecked by others.

The above decision of the Supreme Court brought about a significant change in workers’ attitude towards their own role in the revival and rehabilitation of sick industrial companies, a change from collective bargainers to collective performers. However, in the case before the Supreme Court, the facts were quite favourable for the workers of the company. Though the workers can, through collective effort, achieve the objective of reviving sick industrial units, their own stakes being no less, yet they need all the help and encouragement from the Government, financial institutions and banks for sustained efforts for revival and rehabilitation. Change in attitude of workers’ unions in such an endeavour is all the more important.

Leveraged Buyout (LBO) is defined as the acquisition by a small group of investors, financed largely by borrowing. This acquisition may be either of all stock or assets, of a hitherto public company. The buying group forms a shell company to act as the legal entity making the acquisition. This buying group may enter into stock purchase deal or asset purchase deal. Under the stock purchase device the shareholders sell their stock in the target company to the buying group and then the two firms may be merged. Under the asset purchase mode, the target company sells its assets to the buying group. This exercise aims at generating enormous increases in the market value and value gains for shareholders both who own the firm before the restructuring and after the restructuring.

The leveraged buyouts differ from the ordinary acquisitions in two main ways: firstly, a large fraction of purchase price is debt financed through junk bonds and secondly, the shares of LBOs are not traded on open markets. In a typical LBO programme, the acquiring group consists of a small number of persons/organisations/ sponsored by buy out specialists ,etc. This group, with the help of certain financial instruments like high yield high risk debt instruments, private placement  instruments, bridge financing etc. acquire all or nearly all of the outstanding shares of the target” firm. An attractive candidate for acquisition through leveraged buyout should possess three basic attributes:

  1. It must have a good position in industry with sound profit history
  2. The firm should have a relatively low level of debt and high level of ‘bankable’ assets
  3. It must have stable and predictable cash flows and adequate working capital.

The buyout group may or may not include current management of the target firm. If the group does so, the buyout may be regarded as ‘management buyout‘ or MBO. In other words, when the managers buy their company from its owners deploying debt, leveraged buyout is called management buy out.

A Management Buyout (MBO) is simply a transaction through which the incumbent management buy outs all or most of the other shareholders. The management may take on partners, it may borrow funds or it can organize the entire restructuring, on its own. An  Management Buyout (MBO) begins with arrangement/raising of finance. Thereafter, an offer to purchase all or nearly all of the shares of a company not presently held by the management has to be made which may necessitate a public offer and even delisting. Consequent upon this, restructuring may be affected and once targets have been achieved, then the company can go public again.

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