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Executive Overview
Buyouts, especially leveraged buyouts, have been perceived historically as an organizational efficiency tool to streamline organizational processes, reduce workforces, and decrease unit costs. This efficiency approach has been especially useful with mature firms, where the structure of debt and limits to managerial spending decrease the downside risk and possible failure of the firm. This article illustrates how buyouts can also create entrepreneurial opportunities and allow upside growth. In particular, it focuses on understanding the aspects and circumstances of the entrepreneurial mindsets of managers who seek upside growth through buyouts. These entrepreneurial mindsets provide a wider view of buyouts as a vehicle for renewal that frequently leads to revitalization and strategic innovation. The article provides insights for entrepreneurs, managers, and financiers by articulating four categories of buyout opportunity-efficiency, revitalization, entrepreneurial, and failure buyouts. We specify the conditions under which each may be appropriate, including the governance and financial incentives, and give company examples for each category.
Leveraged buyouts (LBOs) occurring in industries with mature products and stable cash flows have been widely discussed. Value creation in LBOs has usually been associated with improved incentives, concentrated ownership, close monitoring by active investors, and high levels of debt, resulting in such cost efficiencies as reduced labor costs. Most of the attention surrounding buyouts has focused on the pros and cons of these efficiency explanations.
Safeway, a grocery chain, experienced an LBO led by Kolberg Kravis Roberts and Company (KKR) to gain better cost efficiencies. Although the firm undertook considerable restructuring in the early 1980s, it was still underperforming. Its wages were 33 percent above industry averages and there was considerable opportunity for improvement in its operations and management control systems. The debt leverage and incentives introduced by the LBO provided the basis to tackle labor and other problems that management had not fully dealt with beforehand. The buyout was followed by rationalization of distribution, pricing and control systems, renegotiation of labor contracts, and the introduction of more relevant performance-related remuneration for managers. Underperforming divisions were sold, including the disposal of the poorest performing division in Salt Lake City to Borman's for $75 million and the sale of 121 stores in the Dallas division.1 Within two years, all divisions lacking wage parity with competitors and...