Leveraged buyout - Ownership 100%?
Hi everyone was reading up about LBOs. In such instances, is it always necessary for the company to purchase 100% shares of the company? Meaning to say that post-acquisition it is the sole shareholder of the company.
My interpretation of the text online is that they only need to get a controlling share of the entity and so not 100% is necessary. However, if you do not achieve 100% control, how can you then flip the company several years down the road? You might face opposition from other shareholders right?
No, not at all. I'm simplifying things in this example but, in fact, it's often advantageous not to own 100% of the equity. For example, you'll want key members of management to own a small portion to incentivize them and align interests. Maybe the entire equity check for the deal is too big to write out of your own fund for portfolio construction purposes and you bring in a co-investor to own some portion of the equity.
The issue with exiting is solved via drag-along rights that are negotiated as a part of the initial transaction, i.e. when you go to exit, and you own 75%, management owns 5% and an LP co-investor owns 20%, they can be "dragged along" to exit with you.
Hi Hugh,
Many thanks for the reply. So just to clarify, when I buyout a company, it is okay for me to own say 10% interest as long as the remaining 90% belongs to people I can drag along like co-investors and management?
Or should I have at least majority control? I am guessing the company should get at least majority control so that it can elect to put its team into the company to act as advisors.
In the event don't own majority, you likely won't be able to negotiate for drag along rights and the majority owner would, to the contrary, be able to drag you along. They (majority owners) would also have other governance rights like board control, ability to hire / fire management, approve acquisitions, etc. You would typically get minority equity protections like tag along rights (i.e., if the majority owner sells, you can tag along and can sell your shares at the same value as the majority holder) as well as other minority protections depending on the relative size of your investment (e.g., pre-emptive rights, rights of first refusal / offer, maybe some consent rights if you are large enough like approving incremental leverage and M&A activity over certain buckets, etc). Minority equity investments are usually different groups / strategies than your typical buyout LBO funds / firms.
I have seen deals in which the investor has less than 51% but still has "drag along" rights, i.e. the ability to decide when to sell. In both cases that I'm aware of, it was a situation that was basically a growth equity deal with low leverage investor (family office). The founders wanted to keep operational control and wanted to maintain a big stake in the business, but they needed cash. The family office buys 20-30%, but they do it in cash, and they negotiate their ability to pull the trigger on a sale. But, as WSO1212 said, this is not a deal structure that is found in LBO firms.
I think maybe the confusion is that operational control and "drag along rights" (which basically just means "Decider of when we sell") are two different things that can be negotiated separately in theory, though they rarely are in practice.
What do you mean by "okay?"
Drag applies to exit event not to shit like hiring mgmt, m&a
Control really depends upon who else owns equity and how they are aligned.
It does not have to be => 51%, but if you have less than 51% there is always the chance of others aligning against you.
just think of the fight to take Dell private. I am pretty sure they didn't have 100% even in a private company there may be inactive family members w/ partial ownership
Lawyer here, most people have hit the nail on the head. Just two things to add:
If you aren't buying 100% of shares in the target (save for what you're giving to the management team), it will be exceedingly difficult to get bank financing. Your mainstream banks, for example, aren't going to be looking to loan you 60% of the value of a 40% minority stake. The security package will be severely limited. So you'll either need to go all equity (in which case it isn't an LBO), or find specialist lenders to sort you out.
You can negotiate the strongest drag rights in the world, but no one will ever use them. They're there as a threat. I've never seen them used on any of my deals. It looks awful going to the negotiating table and telling the buyer you're going to need to drag X number of shareholders to get them to sell. One of the first things our DD team will look at from the buyside is "who owns the shares" and "is everyone selling".
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I disagree. Banks are still quite eager to work with sponsors, particularly in the MM and even if the prior owner rolls 10% alongside mgmt in an 80% majority recap, lenders aren't going to kill the deal. In the case of a majority recap, I don't remember ever seeing a passive stake beyond 10, maybe 15%.
Don't disagree, but that scenario can easily be structured above the banking group (e.g. a simple rollup, which is what I would expect in that situation). I'm talking a strict situation where you aren't acquiring 100% of target.
For middle market deals, most LBO shops demand control regardless of how much of the company they own. "Control" is dictated by the voting stock of the company, not the percent owned of the common shares. In some cases these are the same security, but not always. For example, an LBO shop might structure the deal where they own 30% of the common shares, various co-investors (such as LPs) own 60% of the common shares, and management retains 10%. In this scenario they would likely create a separate class of non-economic voting shares held exclusively by them, enabling them to force a sale, hire/fire outside board members, or do whatever they wish.
In my experience this is a common means of putting together a deal and banks are happy to support the LBO. They are more concerned with the total debt to equity ratio than the amount of equity coming from the lead sponsor.
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