In financial terms, a buyout is a process to acquire ownership of a company through investing or acquiring the majority of the equity stock of the company. Usually, the acquiring company acquires more than 50% of the paid-up equity capital in the company. The underlying value in the targeted company is undervalued assets that the acquiring company intends to build upon through investing in the opportunity.
Did You Know? Buyouts are often executed through the acquisition of the majority of equity in the targeted company. However, the acquiring company intends to buy out the targeted company from poor mismanagement of debt, forcing it not to liquidate in the process of bankruptcy.
Meaning of Buyout.
A buyout refers to a transaction wherein an acquiring firm acquires control of another company called a company under acquisition either through purchase or acquiring a controlling equity interest in the target company. Buyout usually happens when a company is not performing well in the market, and the market offers opportunities for investments. Such poor performance is characterised by huge debt for the company and very poor cash management resulting in the undervaluation of the company’s assets. On the other hand, the acquiring company assumes good market conditions for the target company to build upon. This creates an opportunity for the acquiring company to invest in the other company and restructure its debt and management in the process to utilise favourable market conditions.
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The Buyout Process.
The buyout process typically begins with an interested acquirer offering a buyout offer to the board of directors of the other company. The board evaluates the proposal and discusses the same in the company's shareholder's meeting. On sufficient consideration, the proposal may be approved by the board on the recommendations of the shareholders.
On approval from the company side, the money to be used for buyout transactions will be released by the acquirer to the individual, companies, or private investment firms who are shareholders in the company as per the buyout offer agreed with the company. On the other hand, The acquirer may be required to arrange the funding for the buyout, which may happen side by side with the process of the buyout. It is worth noting that it is not a lock-step fashion of executing a buyout transaction. Still, the different processes may start at different times according to the conveniences of the intended parties engaged in the buyout process.
Types of Buyouts.
Management Buyouts.
A management buyout occurs when the existing management team of a company acquires all or a major portion of the company ownership from the parent or the holding owner or company. A management buyout is considered an attractive buyout strategy, as managers can expect a greater potential reward by being the company owner instead of mere employees.
It is also an exit strategy for business owners when they want to retire or want to sell a segment of business that is not profitable or not core to their business. This buyout requires a substantial portion of funding which can be a combination of equity and debt.
Leveraged Buyout.
A leveraged buyout occurs when the acquiring company uses a huge sum of debt to finance the acquisition, where the assets of the company under acquisition act as collateral for the debt fund. Leveraged buyout allows a company to acquire a substantial portion of equity of another company without being committed to much of its own funds.
Advantages of Buyout.
There could be an end number of advantages of a buyout for the acquiring firm or the firm under acquisition. However, here is a few of them -
More Efficiency.
Diversification often sounds exciting, but it is very risky, especially for new companies. Through buyout, a company could sell its units of the business that are not core to their main line of business. It may reduce the operational cost of the company leading to increased profitability. While for the acquiring firm, it is an opportunity to extend their line of business into more geographical locations and to new and exciting ventures. The company may make comparison charts to comparison to analyse their processes and choose the one that is better.
Reduced Competition.
A business can increase its profitability by buying its competitors. The buyout often offers a synergy of resources, efforts, and money which together position the company to be more strong in the market. Instead of indulging in price war competition, a buyout may lead to reduced competition and increased profitability for the firms in the market.
New Technology or Products.
Technology is one of the important factors for driving changes in any market. A buyout may bring new technologies to a company from the firm under acquisition. This benefits the company to offer new and updated products in the market that are more attractive to the customers leading to increased sales.
Also, a buyout may bring new products from the firm under acquisition, providing a competitive edge for the acquiring company and new customers under its umbrella. The acquiring firm may benefit by incorporating new products or technology of the firm under acquisition into its current product line, without any need to develop or license new technologies.
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Disadvantages of a Company Buyout
A company acquiring a new firm may bring many advantages that usually outweigh the disadvantages. However, It is quite practical to consider the disadvantages of a buyout also. Here are a few of them -
Increase in Debt.
The acquiring company may need a huge sum of debt to finance the buyout processes. Such a move may badly affect the capital structure of the acquiring company. Having so much debt for the company may put a mark on its operation in times of difficulties. Not every business has good times for every move in the economy.
For example - recently, many Indian startups have laid off a huge chunk of their employees because they could not find funding for their operations. However, A company with a strong competitive position in the market may stay strong with a huge pile of debts, as seen in most of the companies.
Loss of Key Managerial Personnel.
Sometimes company buyouts may result in off time for some of the top key managerial personnel. Finding other personnel with equal expertise, knowledge, and experience is a tough challenge for companies to tackle with.
Integration.
Coordination between people, resources, and business processes is a key success factor for many big corporations. It is quite possible that a huge plunge of time would be required for the two companies to establish a path for better coordination. This may pose a challenge for management to utilise the synergy of resources between the companies. It may lead to a loss of productive time and money.
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Conclusion:
A buyout is a process of gaining a controlling interest in another company, either through purchase or through the acquisition of a majority of equity stock in the other company. It is a result of buyers speculating that the assets of the company are undervalued. It could happen that the acquiring company may want to acquire a financial and strategic advantage such as entry into a new market, increasing customer base, reducing competition, or gaining operational efficiency from the buyout of the company under acquisition. The shareholder also benefits from the buyout believing that the company will fetch more benefits from new management than what could have been delivered from the current management.
It is quite evident that both companies face advantages and disadvantages in some form or another. A buyout could however be taken as a speculative transaction where both the parties are under an impression of common gain, which could be monetary or otherwise.
A buyout is an aggressive strategy of expansion for a firm as it acquires new technologies and products quickly and easily. This possesses a competitive advantage for the company in the marketplace. Hope you enjoyed reading it so far as we have presented an in-depth knowledge of buyout processes, their advantages, types of buyouts, disadvantages, etc.
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