Management Buyout and Preference Shares

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  • Avatar of estherpang87
    • Topics: 12
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    Hi sir,

    In a management buyout, I understand that part or all of a business is bought by the executive managers of the company. Business can be profitable or non-profitable one. so in the case of a loss-making business, like question 1 in Dec 2010, I don’t understand why the management team still want to buy it knowing that it is a loss-making business? I thought they will only buy those profitable businesses.

    Second question is about the preference shares. Is preference shares a debt? It can be redeemable and irredeemable. so for irredeemable, we will calculate the cost of preference share using (Dividend / Market Value of preference shares). But what if it is redeemable, how do we calculate cost of preference shares? do we use IRR approach as one we use in calculating the cost of redeemable debt?

    Also. for preference shares, the nature of preference shares with regard to its dividend payment can either be cumulative of non-cumulative. For cumulative, does it mean that dividend payment can be accumulated, postponed and settled in arrears? whereas non-cumulative means that the dividend payment for a particular year have to be settled in that particular year, no postponement is allowed.

    Sir, I look forward to hearing from you. Please solve my problems. Thank you so much sir.

    Best regards,
    Esther Pang

    Avatar of johnmoffat
    John Moffat
    • Topics: 3
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    The reason management might buy a loss-making business is because they think they can make it profitable, and to preserve their jobs!

    Preference shares are treated as debt for financial management because they get a fixed dividend and are therefore like debt with fixed interest.

    If they are redeemable then you calculate IRR like you would for debt.

    Dividends on preference shares are paid each year provided there are sufficient profits. If there are not sufficient profits then non-cumulative lose what they do not get, whereas cumulative will get it in later years when there is a profit.

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