What is a bust-up takeover?

A bust-up takeover, also called a leveraged buyout, is when a company buys another company using a lot of borrowed money (debt). After buying the company, the new owners sell some of the company’s assets to pay back the debt they took on to buy it.

The company doing the takeover is called the acquiring company. The company being bought is called the target company.

Why do companies do bust-up takeovers?

Companies do bust-up takeovers because they think they can make money. They borrow a lot of money to buy the target company. Then they sell parts of the target company to pay back what they borrowed. They hope that what’s left of the target company will be worth more than what they paid for it.

How bust-up takeovers work

Borrowing money to buy the company

To do a bust-up takeover, the acquiring company borrows a large amount of money. This debt is used to pay for buying the target company. The acquiring company often borrows 60% to 90% of the money needed for the purchase.

Banks or bond investors lend the acquiring company this money. The debt has to be paid back with interest.

Buying the target company

The acquiring company uses the borrowed money to buy shares of the target company. They have to buy enough shares to gain control of the company. This is usually 50% or more of the total shares.

If the target company’s leaders don’t want to sell, it is called a hostile takeover. The acquiring company has to offer a high price per share to get shareholders to sell.

Selling assets to repay debt

Once the acquiring company has control of the target company, they start selling off some of its assets. Assets are things the company owns that have value. This could be property, equipment, product lines, or parts of the business.

The money earned from selling these assets is used to quickly repay the debt taken on to buy the company. The goal is to pay off most of this debt within a few years.

Restructuring what’s left

After selling assets and repaying debt, the acquiring company restructures what’s left of the target company. The goal is to make it more profitable than it was before.

They might cut costs by closing factories, laying off workers, or changing the products and services the company offers. The acquiring company’s leaders take over the management of the target company.

Risks of bust-up takeovers

Bust-up takeovers are risky for the acquiring company. If they can’t sell enough assets to repay the debt, they could go bankrupt. Some other risks are:

• Assets might sell for less money than expected
• The costs to restructure the company might be higher than planned
• The company might not run well after the restructuring
• The people in charge might make bad decisions

Effects on target companies

Bust-up takeovers can be hard on the target company and its employees. Many people often lose their jobs when the new owners cut costs. Parts of the company that took many years to build are sold off.

Some people think bust-up takeovers are bad because they focus on short-term profits instead of the long-term health of the company. Others argue that the restructuring can make the target company stronger and more able to grow.

History of bust-up takeovers

Bust-up takeovers became popular in the 1980s in the United States. During this time, many companies had parts that were worth more than their stock price. This made them attractive targets.

One famous example was the takeover of RJR Nabisco by the private equity firm KKR in 1988. KKR borrowed $24 billion to buy RJR. That was the largest sum of money borrowed for a takeover at that time.

After the takeover, KKR sold off RJR’s food businesses to pay down debt. They kept the tobacco business and took it private. In the years after, KKR restructured the tobacco business and resold stock to the public at a higher price.

Bust-up takeovers became less popular in the 1990s and early 2000s. This was partially because companies learned how to protect themselves from hostile takeovers.

Defenses against bust-up takeovers

Companies can defend against bust-up takeovers in a few ways:

• Poison pill: This lets existing shareholders buy more shares at a discount if a takeover is attempted. This makes the takeover more expensive.
• Staggered board of directors: This makes it so only part of the board can be replaced in any one year. The acquiring company can’t take full control quickly.
• Golden parachutes: These are big payouts to top executives if they’re fired because of a takeover. This makes the takeover more costly.
• Asset lockup agreements: Important company assets are controlled by contracts that block their sale.

Laws about takeovers

Governments make laws that affect how easy or hard it is to do takeovers. In the United States, many states have laws that make hostile takeovers harder. A famous example is the business judgment rule in Delaware. Many companies incorporate in Delaware because of this law.

The laws try to balance the rights of shareholders to sell their stock with the rights of the target company to defend itself. It’s a difficult balance.

Recent bust-up takeovers

Bust-up takeovers still happen today but are less common than in the 1980s. Two recent examples are:

• Kraft takeover by 3G Capital
  In 2013, 3G Capital and Berkshire Hathaway bought Kraft Foods Group. After the takeover, 3G quickly cut costs and laid off many workers. In 2015, they merged Kraft with Heinz to form Kraft Heinz Company.
• Dell takeover by Silver Lake In 2013, Dell Inc. was bought by its founder Michael Dell and the private equity firm Silver Lake Partners. They paid $25 billion, taking the company private. This was the biggest takeover in technology industry history.