Leveraged Buyout (LBO): Is this the acquisition option for you?

A leveraged buyout is a method of acquiring a company. The buyer purchases a company by using the target company’s assets to raise a significant amount of funds and they take on a chunk of debt that will be paid off in the future from the purchased company’s cash flow.

Management Buy In

The most common method of a leveraged buyout is an MBI (Management Buy In). This is where an external buyer/management team buy into a company to purchase either a majority shareholding or 100% of the company. Typically, a leveraged buyout occurs when an external management team are looking to make their first acquisition within an industry and do not have built up cash reserves from already having a trading business in that sector, or if one company is looking to purchase another company that is larger than them and does not have the cash outright for purchase. To bridge the gap, they would then raise additional funds by leveraging the target company’s assets and that debt will be repaid in the future.

Leveraged Buyout: Raising Funds

Leveraging Assets

When looking at what can be leveraged in the target company to raise funds against, there a few things to consider. The first thing to look for is the value of the fixed assets. For example, we have recently sold a vehicle recovery company which held fixed assets of circa £700k. This was the value of all the recovery vehicles and trucks that the company owns. As part of the acquisition in this instance, the buyer raised money against the total value of the fixed assets of the business he bought. There can be other fixed assets such as equipment, plant & machinery if it holds a strong value that can also be leveraged.

Probably the strongest physical asset that you can raise money against is property. If the business owns the property it trades from and wants to include it as part of the sale and if there is no debt (mortgage) on the property, as a rule of thumb you can raise around 70% of the value of the building, assuming it has no debt already on it.

Non-Physical Facilities

There are also non physical facilities in a target company that can be used to raise capital against. In a lot of acquisitions and depending on the nature of the business, a large portion of the value may be made up of the goodwill, which is determined by applying a multiple to the EBITDA (earnings before interest, taxes, depreciation, amortisation). If there are no or very little physical assets to raise debt from, then there is cash flow lending from banks/lenders that will look at the goodwill and future of the business and lend an amount based on the confidence they have in the business over the next few years post sale. This involves a lot of detailed financial projections, cash flow projections as well as financial modelling. Typically, it is best to put together a picture of the business over the next 3 years post sale and depending on the confidence levels from banks, will then determine how much capital they feel comfortable with lending.

Invoice Financing

One final method of raising funds on a business, is called invoice financing and that is done by assessing the target company’s debtor book (money owed to the business) and lenders will lend a high percentage of the total debtor book, which is just the total amount of outstanding invoices that are due and haven’t been paid yet by customers. Recently I have seen percentages around 80-85% of the total outstanding invoices amount be given. Some companies even have a confidential invoicing facility with their business bank and they will give 90% of the total debtors. This was brought in to assist companies with their cash flow if they were waiting on money to come in but needed some immediate cash to help with running their business, but it is a clever tool that can be utilised to help with funding an acquisition, especially if a company has a large debtor book, as a big chunk of money can be drawn down from it.

Is a leveraged buyout the option for you?

In summary, a leveraged buyout can be a great method of acquiring businesses. The acquisitions landscape has changed significantly and it is very rare for any acquisition to happen without any funding or deferred consideration involved. Long gone are the days of getting all your money upfront and in the current economic climate it is about working together to achieve a successful sale by receiving a majority percentage of the total value initially and the remaining balance deferred over the next few years. If buyer and seller can come to an agreement on what will be paid upon completion initially and a structure on the remaining payments and a leveraged buyout can achieve this, then it is perfect for both buyer and seller. Seller gets what they need initially and the buyer is able to purchase a company without risking any capital of their own.