An institutional buyout (also known as IBO) is a type of acquisition (buyout) in which an institutional investor such as a venture capital firm, private equity firm, or a financial institution (e.g., bank) purchases a controlling interest (at least 51%) in a company. The institutional buyout is a common way to make a public company private.
An institutional buyout is a direct opposite of a management buyout (MBO). In a management buyout, the existing management of a company acquires the whole company or a part of it. At the same time, the leveraged buyout (LBO) can be considered as a type of institutional buyout in which a transaction involves a high degree of financial leverage. In other words, in leveraged buyouts, the institutional buyers acquire a target company primarily using borrowed funds.
Key Features of a Target Company
Financial institutions or institutional investors who specialize in institutional buyouts generally focus on specific industries and target companies of a particular size. Although the characteristics of a target company vary among industries, some key features remain persistent.
For example, the ideal target company for an institutional buyout is typically an underperforming company in its own industry. Despite the underperformance, a target company is still capable of significant cash generation and reports stable cash flows. In addition, an ideal target company possesses an additional debt capacity (such a characteristic is extremely important if an institutional buyer wants to undertake a leveraged buyout), as well as low capital spending requirements.
Frequently, institutional buyouts lead to the replacement of the current management team of the target company. Due to such a reason, the managers of the target companies may try to oppose the transaction. Thus, many institutional buyouts are executed as hostile takeovers. However, in some cases, institutional buyers may decide to keep the current management.
Institutional buyouts generally feature a specific time frame. Usually, institutional buyers adopt an investment horizon of between five to seven years. During the holding period, the buyers intend to increase the company’s value by optimizing and/or restructuring its core business operations.
At the end of the specified time frame, an institutional buyer disposes its investment by selling the controlling interest in a company to another external party or through an initial public offering (IPO). One of the most common exit strategies in the institutional buyouts is the sale of the target company to a strategic buyer.
A strategic buyer is an acquirer operating in the same industry as the target company. Through the acquisition, the goal of a strategic buyer is the integration of a company in its core operations and improvement of business by realizing the synergies between two companies.
Stages of Institutional Buyouts
Like any other type of business acquisitions and financial transactions, institutional buyouts are sophisticated and time-consuming processes. Here, we will discuss the common stages of the institutional buyout deals. The different stages include:
Stage 1: Identify the target company
Every IBO deal starts with the identification of a suitable target company by an institutional buyer (private equity or venture capital firm). Each institutional buyer comes up with its own requirements for the ideal target company. Based on the chosen criteria, an institutional buyer conducts the research and analysis of companies suitable for a potential buyout.
Stage 2: Structure the deal offer
When an institutional buyer decides on a company suitable for the IBO, it must also select the appropriate deal type. For example, the buyer may decide what type of funds it will use for the acquisition of the stake in a company (own or borrowed).
Also, the buyer must elaborate on what price it will pay to the current shareholders of a company (including the size of premium), as well as the decision regarding the current management (whether to keep the existing management or replace it with a new team).
Stage 3: Make an offer to a target company
Upon the completion of structuring the deal’s offer, the institutional buyer makes an offer to the shareholders of the target company. If the shareholders agree to accept the offer, the ownership over a company (partial or whole depending on the terms of a deal) is transferred to the institutional buyer. However, in some cases, the institutional buyer could face resistance from the existing management of a company
Stage 4: Manage the target company
After transferring the ownership of the target company to the institutional buyer, new owners of a company will likely to start adjusting the company’s operations to increase its value. The governance of a company is executed through the managers, who will ensure that a company develops according to the vector chosen by the institutional investor.
Stage 5: Exit the investment
Institutional buyers generally hold their investments for five to seven years. At the end of the holding period, the institutional buyer will exit its investment to realize the appreciation value. The most common exiting strategies include the sale of the stake to the strategic buyer and an IPO.
In case of the sale of a target company to the strategic buyer, a target company is acquired by a company operating in the same industry. However, if the institutional buyer expects further growth opportunities for the target company, an IPO may be a better option.