PA SGS 9 – Management Buy Outs
Lecture notes:
Learning outcomes
• Structure of LBO (acquisition partly funded by debt)
• Features of MBO
• Use of private equity funding
• Tax issues of MBO
What is a private equity fund?
• Raising capital from its investors and pooling it into a fund, an investment
vehicle
• With this money, makes equity + debt investments in portfolio companies.
These portfolio companies acquire businesses.
PE Structure
,The fund = the limited partner, sets up newcos, which are the acquisition
vehicles (i.e the buyer) that acquire businesses.
Red line = separates the two halves.
Top half = the fund structure
Bottom half = acquisition structure
Fund structure = limited partnership.
Investors are the limited partners and the general partner is the private equity
firm.
In order for the main partners to benefit from limited liability, cannot participate
in general management.
® General partner = makes money from management fees from investors
and carried interest, i.e percentage of profits (fixed).
® Benefit? Tax transparent, no entity level tax. No tax at the partnership
level.
® A partnership = look through structure. Eliminates double tax, whereas
double taxation with company who gets taxed on profits + its investors
taxed on dividends).
More detail on bottom half of structure:
,Plus: additional parties involved in management buy out
So:
Management team dotted line to Target = because management team used to be
the management of target, but on an MBO, the Management team is subscribing
for shares in the newco acquisition vehicle. So indirectly managing it.
Target company = profit making company, trading company that gives dividends
to Newco and flows up to the investors.
PE and governance?
3 main types of private equity activity:
• Venture capital
• Development or growth capital
, • Buy-out (MBO/MBI)
o MBI = new management team from the Fund, whereas MBO is the
same one.
Standard MBO Structure:
MBO: basically, the existing management of a target getting together with a PE
fund and buying the shares of the company between them.
2 Newco structure here; the management team subscribes for the shares in a
newco which will be owned by the Fund partnership as well (so fund subscribes
for shares in newco 1).
So; newco 1 = investment vehicle; the management and the PEF subscribe for
shares here. HERE – this is where the money is going into and debt is being
issued from (if issuing debt securities in form of loan notes / debt securities).
Newco 2 = acquisition vehicle. Newco 1 subscribe for shares in Newco 2 which
becomes a subsidiary of NewCo 1, and it is newco 2 that is the BUYER of the
target company.
1. Management team putting their cash into Newco 1 in return for shares
and sometimes loan notes.
2. Equity funds putting their money into Newco 1 and receiving shares and
some form of debt securities, loan notes/pref shares.
SO = all of this money is in newco 1 but it needs to trickle down into NewCo 2
since they are the buyer.
So: NEWCO 1 will either loan the money to NEWCO 2 so they can use it to buy
shares in Target, OR newco 1 subscribes for more shares in Newco 2 for cash.
Either method can be used.
Lecture notes:
Learning outcomes
• Structure of LBO (acquisition partly funded by debt)
• Features of MBO
• Use of private equity funding
• Tax issues of MBO
What is a private equity fund?
• Raising capital from its investors and pooling it into a fund, an investment
vehicle
• With this money, makes equity + debt investments in portfolio companies.
These portfolio companies acquire businesses.
PE Structure
,The fund = the limited partner, sets up newcos, which are the acquisition
vehicles (i.e the buyer) that acquire businesses.
Red line = separates the two halves.
Top half = the fund structure
Bottom half = acquisition structure
Fund structure = limited partnership.
Investors are the limited partners and the general partner is the private equity
firm.
In order for the main partners to benefit from limited liability, cannot participate
in general management.
® General partner = makes money from management fees from investors
and carried interest, i.e percentage of profits (fixed).
® Benefit? Tax transparent, no entity level tax. No tax at the partnership
level.
® A partnership = look through structure. Eliminates double tax, whereas
double taxation with company who gets taxed on profits + its investors
taxed on dividends).
More detail on bottom half of structure:
,Plus: additional parties involved in management buy out
So:
Management team dotted line to Target = because management team used to be
the management of target, but on an MBO, the Management team is subscribing
for shares in the newco acquisition vehicle. So indirectly managing it.
Target company = profit making company, trading company that gives dividends
to Newco and flows up to the investors.
PE and governance?
3 main types of private equity activity:
• Venture capital
• Development or growth capital
, • Buy-out (MBO/MBI)
o MBI = new management team from the Fund, whereas MBO is the
same one.
Standard MBO Structure:
MBO: basically, the existing management of a target getting together with a PE
fund and buying the shares of the company between them.
2 Newco structure here; the management team subscribes for the shares in a
newco which will be owned by the Fund partnership as well (so fund subscribes
for shares in newco 1).
So; newco 1 = investment vehicle; the management and the PEF subscribe for
shares here. HERE – this is where the money is going into and debt is being
issued from (if issuing debt securities in form of loan notes / debt securities).
Newco 2 = acquisition vehicle. Newco 1 subscribe for shares in Newco 2 which
becomes a subsidiary of NewCo 1, and it is newco 2 that is the BUYER of the
target company.
1. Management team putting their cash into Newco 1 in return for shares
and sometimes loan notes.
2. Equity funds putting their money into Newco 1 and receiving shares and
some form of debt securities, loan notes/pref shares.
SO = all of this money is in newco 1 but it needs to trickle down into NewCo 2
since they are the buyer.
So: NEWCO 1 will either loan the money to NEWCO 2 so they can use it to buy
shares in Target, OR newco 1 subscribes for more shares in Newco 2 for cash.
Either method can be used.
