Management buyout (MBO)
A management buyout is a transaction in which the current managers of the company (not necessarily members of the management board as such) take control over the company by buying out a controlling stake in the company’s shares-either independently, out of their own funds, or in cooperation with investment funds, such as a private equity fund. Because an MBO involves the current managers, it should be distinguished from a “management buy-in” (MBI), in which the buyout is conducted from “outside”, by persons other than the current management who plan to assume management of the company in the future, or a “buy-in management buyout” (BIMBO), which combines the features of an MBO and an MBI.
The first essential characteristic of MBO transactions is the manner in which they are financed and the source of the financing.
Although an MBO is understood as a buyout of the shares of a company by managers committing their own funds, in practice the managers are rarely in a position to put together enough capital to buy out the company. Reviewing MBOs over the past few years, the average equity put up by the managers themselves is perhaps 10-20%, and most of the funds come from bank loans.
Because the main security for repayment of the bank loans is the shares that are bought out, and the obligation to repay the debt is shifted to the acquired company, the main factor enabling the managers to obtain financing for the acquisition is the creditworthiness of the target company itself. Banks review MBO proposals very cautiously, checking all aspects of the sector in which the target currently does business, the company itself, and the membership and quality of the management team. The last factor is crucial, as the managers are expected to present a carefully thought-out business plan for the target, together with a timeframe for the investment and a repayment schedule. The managers also need to be aware of the financial limitations the company will operate under during the debt repayment period, such as the inability to take on major investments, incur new loans for current activity, or issue shares.
Thus banks look much more favourably on managers who are supported by capital partners, such as private equity funds. The presence of capital partners increases the credibility of the projects presented by the managers, because they have been reviewed and approved by the funds deciding to invest in them. Support from a fund also reduces the amount of debt financing and thus the risk of insolvency.
Transaction structure-use of SPV
Another feature of an MBO is the use of a special-purpose vehicle (SPV) to carry out the acquisition. The funds for purchasing the shares are contributed by the managers to the SPV, which then acquires the shares from the current shareholders of the target.
After the SPV acquires the shares of the target, a “debt push-down” is carried out, in which the debt is shifted to the target, so that the company itself can repay the debt incurred to purchase the shares. The debt push-down is carried out by merging the target company and the SPV.
The managers have a thorough understanding of the business and the financial condition of their own company, and they will decide to conduct an MBO when they believe that the company is undervalued by the market, compared to its true potential and growth prospects.
MBOs are regarded as non-transparent and may raise suspicions that they involve insider trading, because the acquirers, as managers, know more about the target even than the seller, i.e. the owner of the company.
MBOs raise the issue of “financial assistance” from a joint-stock company to third parties-in this case, the managers-in acquiring or taking up shares issued by the company.
Prior to the June 2008 amendment (Journal of Laws No. 118 item 747) to the Commercial Companies Code, Art. 345 of the code generally prohibited a joint-stock company from providing this kind of financial assistance, directly or indirectly, specifically when it involved providing loans, advances or security. This rule was intended to protect the shareholders and creditors of a joint-stock company. In effect, the assets of a joint-stock company taken over by the managers could not serve as security for repayment of credit granted to the SPV, and thus the bank could not expect to obtain security for repayment against the assets of the target until the SPV was merged with the target.
Under current law, a joint-stock company may finance acquisition or taking up of shares issued by the company, but the financing must be made on market terms and the shares must be acquired or taken up in exchange for fair market value. The company may finance acquisition or taking up of shares issued by the company if a capital reserve has first been created for such purpose. Financing by the company of acquisition or taking up of shares issued by the company requires adoption of a resolution of the general meeting of shareholders by a two-thirds majority, but if at least half of the share capital is represented at the meeting, an ordinary majority is sufficient.
Art. 345 §8 of the Commercial Companies Code excludes these requirements (except for the requirement to create a capital reserve) with respect to benefits provided within the ordinary course of business of financial institutions, as well as benefits provided to employees of the company or an affiliated company. The exclusions referred to in Art. 345 §8 do not apply to managers, however, unless a member of the management board is also an employee of the company.
If the target of an MBO is a limited-liability company, there are only modest limitations on financial assistance by the company. Restrictions arise chiefly under Commercial Companies Code Art. 189 §2, which prohibits the company from making payments to shareholders out of the assets of the company that would reduce the assets needed to fully cover the share capital. Thus an MBO would be impermissible if financing were provided to shareholders (and only shareholders) out of funds necessary to cover the share capital. (This particularly concerns a situation where coverage of the share capital was reduced as a result of losses incurred by the company.)