What Is an Institutional Buyout (IBO)?

An institutional buyout (IBO) refers to the acquisition of a controlling interest in a company by an institutional investor such as a private equity firm, venture capital firm or financial institution such as a commercial bank. Buyouts can be of public companies as in a “going private” transaction, or of private ones by direct sale. Institutional buyouts are the opposite of management buyouts (MBO), in which a business's current management acquires all or part of the company.

Understanding Institutional Buyout (IBO)

Institutional buyouts (IBOs) may take place with the cooperation of existing company owners, but are termed hostile when launched and concluded over the objections of existing management. An institutional buyer may decide to retain current company management after an acquisition. But often the buyer prefers to hire new managers, sometimes giving them stakes in the business. In general, the private equity firm involved in the buyout will take charge in structuring and exiting the deal as well as hiring managers.

Institutional buyers typically specialize in specific industries as well as targeting a preferred deal size. Companies that have unused debt capacity, are underperforming their industries but are still highly cash generative, with stable cash flows and low capital spending requirements make attractive buyout targets. Typically, the acquiring investor in a buyout will look to dispose of its stake in the company via sale to a strategic buyer (for instance an industry competitor) or through an initial public offering. Institutional buyers target a set time frame, often five to seven years, and a planned investment return hurdle for the transaction.

Leveraged Buyouts

Institutional buyouts are described as leveraged buyouts (LBOs) when they involve a high degree of financial leverage, meaning they are made with predominantly borrowed funds.

Leverage, as measured by debt to EBITDA ratios for buyouts, can range from four to seven times. The high leverage involved in LBOs increases the risk of deal failure and even bankruptcy if the new owners are not disciplined in the price paid, or are unable to generate the planned improvements to the business through increasing operational efficiency and reducing costs enough to service the debt taken on to finance the transaction.

The LBO market reached its peak in the late 1980s, with hundreds of deals being completed. KKR’s famous acquisition of RJR Nabisco in 1988, cost $25 billion and relied on borrowed money to finance close to 90% of the transaction cost. It was the largest LBO of its time.