Buyout
A private equity transaction in which investors acquire a controlling interest — typically 51% or more of the share capital or voting rights — in a target company; with significant leverage, it is an LBO.
In plain language
Most AIF investments are minority stakes: the fund buys part of a company and relies on contractual rights to protect itself. A buyout is the other kind. The investor takes control.
The workbook describes private equity participating in "more complex transactions involving control acquisitions (known as 'buyout') and Leveraged Buy Outs (LBOs) which comprise of doing buyouts with significant leverage". In such transactions, "investors typically look to acquire controlling interests of either 51% or more of the share capital or voting rights of a target company".
Chapter 6 puts it from the fund's side: equity investments "may also be positioned for taking controlling positions in investee companies. Sometimes AIFs co-invest in control acquisitions or finance acquirers of other companies with debt or mezzanine capital. Such transactions are known as 'buyouts' and if leverage is used, they are known as Leveraged Buy-Outs (LBOs)."
How it works
What counts as control. The workbook's footnote on control interest: shareholding or voting rights that provide management control. "The minimum such rights are 51% which provide simple majority control. Sometimes, such rights may also be accorded through a specific contract instead of voting rights."
Three ways an AIF takes part.
- Acquire control itself — a control investor, or "buyout fund".
- Co-invest in a control acquisition led by someone else.
- Finance an acquirer with debt or mezzanine capital.
Leverage and mezzanine. Where a buyout uses leverage it is an LBO. The workbook notes that mezzanine finance is used where large cash flows are forecast contingent on unlocking value — from a new project, corporate restructuring or leveraged buyouts. The mezzanine financier lends against those future lumpy cash flows but requires an adequate return, often by attaching warrants or a conversion option into equity.
History. Globally, after 2004 the stage was set for larger PE funds to enter the control acquisitions market, which is "presently a large segment of the global private equity and M&A market". In India, buyout transactions were spearheaded by funds such as Blackstone, KKR and Actis, which acquired controlling interest in both listed and closely held companies; the buyout of Flextronics by KKR in 2006 was a landmark deal.
In fund due diligence. Investors ask a manager whether it prefers to be a control, minority, joint or sole investor, what controls and rights it seeks, and — "if predominately a control investor (buyout Fund)" — under what scenarios it would take a non-control position.
Why control matters at exit. A minority stake can suffer a minority or non-marketability discount on sale. A stake large enough to carry control can attract a control or strategic premium — which is why a minority AIF negotiates a drag-along right over promoters.
A worked example
Illustrative figures. Two AIFs look at the same Indore packaging company, valued at an equity value of Rs 400 crore.
Growth deal. Fund A buys 20% for Rs 80 crore. The promoters keep control. Fund A protects itself with affirmative rights, a board seat and a drag-along.
Buyout. Fund B buys 55% from the promoters for Rs 220 crore, taking control of the board and management. Because 55% is above 51%, it has simple majority control through its voting rights.
Leveraged buyout. Fund B funds the Rs 220 crore as follows:
| Source | Rs crore | Share |
|---|---|---|
| Fund B's equity | 90 | 41% |
| Senior acquisition debt | 90 | 41% |
| Mezzanine debt with warrants from a debt AIF | 40 | 18% |
| Total | 220 | 100% |
With Rs 130 crore of the Rs 220 crore borrowed, this is a buyout "with significant leverage" — an LBO. The debt AIF has lent against the company's future cash flows, taking warrants so it shares in equity value at exit.
If the company's value rises 50% to Rs 600 crore, Fund B's 55% is worth Rs 330 crore. After repaying Rs 130 crore of debt — and ignoring interest and the warrants — Fund B's own Rs 90 crore has become about Rs 200 crore, roughly 2.2 times, where an unlevered buyer would have made 1.5 times. The same leverage magnifies a fall.
Why NISM asks about it
Chapter 1 (Overview of Alternative Investments) introduces buyouts and LBOs within private equity at 1.2.2 and in the history of the industry; Chapter 2 (Alternative Investment Funds in India) records the Indian buyout deals; Chapter 6 (Risk and Return) places buyouts among equity investments and mezzanine finance; and Chapter 8 (Fund Due Diligence) asks about a manager's control preference. Expect a definitional question on the 51% control threshold and on what makes a buyout "leveraged".
Common exam traps
- Control means 51% or more of share capital or voting rights — the simple majority. It can also be given by contract.
- A buyout with significant leverage is an LBO. Leverage is what distinguishes them, not size.
- An AIF need not be the acquirer. It may co-invest in a control acquisition, or finance the acquirer with debt or mezzanine capital.
- Mezzanine finance is linked to LBOs because it lends against future cash flows that the buyout is expected to unlock, usually with warrants or conversion.
- "Private equity" in the workbook normally means later-stage growth capital; buyouts are the more complex, control end of it.
- Do not confuse a buyout with a buy-back. A buy-back is an exit in which the company or promoters purchase the AIF's shares under a put option.
Check yourself
1.In a buyout transaction, private equity investors typically look to acquire a controlling interest of:
- a)10 per cent or more of share capital
- b)26 per cent or more of share capital
- c)51 per cent or more of the share capital or voting rights of the target company
- d)75 per cent or more of share capital
Show the answer
Answer: (c) 51 per cent or more of the share capital or voting rights of the target company
Private equity participates in more complex transactions involving control acquisitions, known as buyout, and Leveraged Buy Outs which comprise of doing buyouts with significant leverage. In such transactions, investors typically look to acquire controlling interests of either 51 per cent or more of the share capital or voting rights of a target company. The distinction between a buyout and an LBO lies in the leverage used, not in the stake acquired.
2.The first characteristic private equity transaction in India is arguably:
- a)the KKR buyout of Flextronics Ltd in 2006
- b)the USD 292 million investment by Warburg Pincus in Bharti Televentures Ltd
- c)the establishment of the National Infrastructure Investment Fund in 2015
- d)the SIDBI fund of funds for start-ups
Show the answer
Answer: (b) the USD 292 million investment by Warburg Pincus in Bharti Televentures Ltd
The workbook records that the first characteristic private equity transaction in India is arguably the USD 292 million investment made by Warburg Pincus in Bharti Televentures Ltd, which also resulted in a successful exit strategy for the fund when Bharti was taken public with its IPO in 2002. Option (a) is a real landmark but of a different kind — the buyout of Flextronics Ltd by KKR in 2006 was a landmark deal, marking the arrival of buyout transactions rather than the first PE investment.
Where this is taught
Free preparation for NISM Series XIX-ARelated terms
- Co-investmentInvestment by a manager, sponsor or investor of a Category I or II AIF directly into an investee company that the AIF is itself investing in, alongside the fund rather than through it.
- Drag Along (Bring Along) RightAn exit right obliging other shareholders — typically the promoters — to sell their shares to the same buyer on the same terms when the AIF holding the right chooses to sell.
- Leveraged Buy-OutA control acquisition of a company financed substantially with borrowed money — a Private Equity buyout where the acquirer typically targets 51% or more of the target's share capital or voting rights.
- Mezzanine CapitalCapital provided in a hybrid structure carrying features of both debt and equity — typically subordinated debt with an equity upside attached, such as warrants.
- Private EquityEquity capital raised by companies from external investors without going to the public markets — direct investment in businesses that are not listed on a stock exchange.
- Strategic SaleAn AIF's exit by selling its stake in a portfolio company to a corporate buyer in the same or an adjacent industry — usually the second most preferred exit after an IPO.
- Taking privateA buyout of a listed company by acquiring the shares held by the public — in India through SEBI's delisting process for promoters, or a Takeover Code open offer for an external acquirer.
- Club DealA buyout in which several private equity investors act in concert to acquire the controlling stake, because no one fund can or will write the whole cheque.
- Management Buy-inA buyout in which an outside management team is assembled to run the target, used where the company's existing managers cannot supply what a buyout needs.
- Special purpose acquisition vehicleThe company incorporated for a leveraged buyout to pool the debt and equity capital and give the lenders a ring-fenced secured structure, sitting between the investors and the target.
- Priority of ClaimsThe order in which a borrower's money reaches its providers: secured debt by seniority of charge, then unsecured debt in full, then preference capital, and only then equity.