when a LBO purchases all common stock, the control of the target firm shifts to a) the LBO firm b) management and the LBO firm please explain your answer.
The LBO firm or the consortium of LBO firms will always have “control”, through a majority of stock ownership but also through management agreements and other executory contracts. Management may have a stake through rollover, which is when management’s preexisting interest in the pre-LBO company is carried over into the post-LBO company which will usually result in management owning a greater percentage of the post-LBO company. Assume EV=100 and D=25 and E=75. If management owns 10, which it rolls over, and the LBO sponsors put in equity of 30 and use debt for the rest, management’s interest will go from 13% to 25%. Management may also receive options. Even though management has skin in the game, I would argue that the LBO firm is still very much in control. I’ve seen structures in which management’s existing ownership has to “re-vest”, plus the LBO firm will virtually always have kick-out rights to fire management and will also have drag along rights in the event the LBO firm wishes to sell the company or take it public.
Unless management is a major stock holder and can refuse to sell their shares, why would management still have control over the firm. Yes, they have de-facto control over day to day operations, but the LBO firm holding all the equity can still fire them or (if their contracts don’t allow firing) at least move them around. If management has stock options or warrants that can be executed to dilute the LBO’s control, I guess they could exercise some control; however it’s unlikely that there would be enough options to overrule the LBO with the rest of them. However, if the LBO firm takes the company private, I’m not sure what happens to options and warrants. So I’d say it’s A, normally, and B under some very limited circumstances.
Many stock comp/warrant plans have change in control provisions which accelerate unvested options in the event of a qualified change in control. This also goes for the equity component of hybrid instruments like convertible debt. Aside from the accelerated vesting, I’ve also seen some with an adjusting strike price in order to make up for some of the lost time value in the options.
An LBO doesn’t purchase anything, it’s a transaction. Whoever is buying the company owns it, whether they be management or otherwise
the answer is B…Schweser.
Agreed with soma80 and bchadwick. By definition, management will not have a majority stake following an LBO buyout, because it is the PE firm that contributes the majority of the equity. If Schweser says it’s B, it is a total joke.
It’s a dumb question
very.