Institutional Buyout (IBO)

Refers to an institutional investor’s acquisition of a controlling interest in a firm.

Himanshu Singh

Reviewed by

Himanshu Singh

Expertise: Investment Banking | Private Equity


September 2, 2023

What Is an Institutional Buyout (IBO)?

An institutional buyout (IBO) is an institutional investor’s acquisition of a controlling interest in a firm. Institutional investors include private equity or venture capital firms, as well as financial institutions like commercial banks. 

Institutional investors specialize in particular industries and usually have a preferred deal size. These investors also establish a set time frame (usually five to seven years) and a projected investment return hurdle for the deal. 

A hurdle rate is the minimum rate of return on an investment that will cover its costs. 

Often, institutional buyouts are a way to make a public company private. Other IBOs may involve private buyouts by direct sales. 

The opposite of an institutional buyout is a management buyout (MBO). In a management buyout, a company’s current management acquires some or all of the company. 

Like other types of acquisitions, IBOs can be friendly when the transaction is approved by the company’s current owner(s). However, an IBO can also be hostile if the transaction does not align with the owner(s)’s objectives. 

Understanding institutional buyouts

As mentioned, these may be friendly when the transaction cooperates with the existing company owner(s). However, the transaction may be hostile when it bypasses the existing management’s objections. 

After an IBO occurs, the institutional investor may decide to preserve the company’s current management. More often, however, the institutional investor chooses to hire new management and may decide to give them stakes in the company. 

Private equity companies that are involved in buyouts typically structure and execute the deal, as well as hire new managers.  

Institutional buyers seek out deals of their preferred size and focus on specific industries. 

A company may be a desirable buyout target if it carries a lot of unused debt, may be underperforming but still generates a lot of cash, and has consistent cash flows with low capital expenditure requirements. 

Usually, an acquiring buyer will look to get rid of its stake in the company through a sale to a strategic buyer (e.g., an industry competitor) or an initial public offering (IPO). 

An IPO occurs when a private company first sells its shares to the public. It is a transition from private ownership to public ownership, commonly called “going public.”

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Stages of Institutional Buyouts

The stages are:

1. Identify the target company

First, the institutional investor must find a suitable target company. Then, the institutional buyer can establish their requirements for the desired target company. 

Once the criteria are chosen, the institutional buyer researches and analyzes appropriate companies for a buyout. 

2. Structure the deal offer

Once the institutional buyer finds the ideal company for the IBO, it needs to choose an appropriate deal type. For instance, the institutional buyer can choose what type of financing it will use for the acquisition of a stake in the company (i.e., loan or no loan).

The buyer also needs to set a price that it will pay current shareholders of the target company, as well as the size of the premium. The investor will also take into consideration whether or not it desires to keep the current management or replace it. 

3. Make an offer to the target company

Once the deal is structured, the institutional investor will propose an offer to the current shareholders of the target company. If the offer is agreed upon, either whole or partial ownership of the company will be transferred to the investor. 

4. Manage the target company

After ownership of the target, the company is transferred to the buyer; the company’s new owners will usually start changing its operations to increase its value. 

Managers of the company will oversee the company’s development in accordance with the investor’s chosen path. 

5. Exit the investment

Typically, institutional buyers maintain investment for five to seven years. Once the holding period is up, the buyer will exit the investment in order to obtain the appreciated value. Selling the stake to a strategic buyer or through an IPO are common strategies for exiting. 

If a strategic buyer buys the target company, it means that the firm was acquired by a company that operated in the same industry. On the other hand, an IPO may be ideal if the institutional buyer predicts more growth opportunities for the target company. 

IBO vs. Leveraged Buyouts (LBO)

A leveraged buyout (LBO) is a type of institutional buyout that involves using a large amount of financial leverage. This means that an LBO is made using mostly borrowed funds. 

For buyouts, leverage is measured using the debt-to-EBITDA ratio. If an LBO has a higher degree of leverage, the deal is riskier and may face failure or bankruptcy. 

This risk can be mitigated if the new owners of the acquired company are disciplined in making payments and business improvements that increase efficiency and reduce costs. But, of course, all of this is in order to pay off the debt used to fund the acquisition. 

Private equity firms typically carry out leveraged buyouts. They usually occur when the target company has significant free cash flow, adequate net tangible assets, and low levels of debt. 

When this is the case, the buyer borrows against the target’s balance sheet and uses the loaned funds for the acquisition of the target. 

Leveraged buyouts are considered to be high-risk, high-reward investment strategies. This is because the acquisition of a company using a large amount of debt must achieve high returns and cash flows to pay interest on the borrowed funds. 

Key Features of a Target Company

Institutions or investors who carry out IBOs generally focus on one industry and target a specific size. Features of a target company tend to vary among industries; however, some key characteristics remain constant.

1. Underperformance 

A good target company for an IBO is usually one that is underperforming in its own industry. Despite its underperformance, the target should have considerable cash generation and consistent cash flows. These firms are ideal because there is an opportunity to cut costs and increase earnings. 

2. Additional debt capacity 

A target company must carry an additional debt capacity if an institutional investor is looking to carry out a leveraged buyout. 

3. Low capital spending requirements 

In addition to a high debt capacity, low capital spending requirements are desirable for a leveraged buyout target. 

4. Replacement of old management team

Oftentimes, an IBO results in the replacement of the target company’s old management team. Sometimes, the target company may try to stop the transaction due to this reason. As a result, many IBOs are carried out as hostile takeovers

5. Timeframe

Institutional investors typically establish an investment horizon of five to seven years. The investors’ goal is to increase the target’s value during the holding period through optimizing and sometimes restructuring operations. 

6. Sale of controlling interest

At the end of the established time period, the institutional buyer exits through a sale of its controlling interest in the company to another investor, through an IPO, etc. Typically, the sale is made to a strategic buyer. 

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Researched and authored by Rachel Kim | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

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