M&A Vocabulary – Experts explain: MBO, MBI, LBO

In times of global uncertainty caused by factors such as pandemics, armed conflicts, higher logistics risks, and rising economic tensions, some companies are considering divesting (unprofitable) parts of their corporate groups or selling lines of business that are only slightly profitable in order to generate liquidity reserves.

But also investors are facing said uncertainties and therefore the decisive factor can be to what extent a potential buyer is in a position to evaluate the potential risks, but also the opportunities that arise for the target company as a result of an acquisition. Because it is the management of the “target company” that has the inside knowledge of the company and an overview and the most relevant information about these topics, an acquisition of the company directly by the management and, possibly, other corporate managers, can be a veritable alternative to an acquisition by a strategic or financial investor. 

Such Management Buy-Out (MBO for short) usually involves similar process steps as a classic transaction, but the requirements relating to Due Diligence are usually much less stringent since the management as the buyer generally has access to more information than the seller. Also the scope of the covenants or reps and warranties issued by the seller will usually be much more limited than the scope that is normally expected in acquisition transactions. 

Therefore, one of the critical issues in an MBO is the preparation of a proper valuation of the target because, usually, it is a target’s management that prepares detailed information for the selling shareholder on how the purchase price is to be calculated, which, in this case, is, however, possible only to a limited extent due to the existing conflict of interest. On the other hand, the question of financing the purchase price should be clarified, because in very few cases do members of the management have sufficient funds to acquire the target even if they pool their financial resources together. Therefore, an MBO is also considered a form of a Leveraged Buy-Out (LBO for short), i.e. a corporate transaction involving a significant amount of borrowed money provided by financial sponsors. Besides banks, which are often reluctant to finance such MBOs due to high risk-management requirements, financial sponsors are often mezzanine capital providers, private equity or even venture capital investors.

To avoid making the deal structure overly complex, members of the corporate management set up a joint venture that directly acquires the target or, if private equity investors are involved in financing, together with the financial sponsor they acquire an acquisition vehicle through which they buy the target. Depending on the financing structure, a debt-push down may occur. 

Management Buy-In (“MBI” for short) is another way a company may be acquired by the members of a corporate management team, who often view themselves as better suited to make the company profitable or more profitable than the existing shareholder. As opposed to an MBO where a company is acquired by its internal management, an MBI takes place when an external management team acquires a company and in this process replaces the existing management team. If that team can boast a portfolio of successful acquisitions in which the acquired companies were restructured and then sold to a strategic investor at a profit or perhaps even floated on the stock exchange, it is easier to attract external capital providers to finance the transaction than in the case of an MBO in the case of which the participating managers have indeed a good understanding of the company but have not been able to achieve a satisfactory level of profitability with the target company up until the date of the transaction.