Is an LBO with Private Equity Good for My Company?
An LBO or Leveraged Buyout is the purchase of a company while primarily using debt to finance the transaction. LBOs are common with private equity (PE) firms.
Generally, the company conducting the LBO or takeover must only provide some of the financing, but they still can make a large purchase through the use of debt (“leveraging” the debt).
Years ago, when LBOs were red hot in business, debt could make up 90% of the purchase of a company; but these days, investors and private equity firms are much more risk adverse. Today’s LBOs use around 50% debt and 50% equity to purchase a business.
The investors and private equity firms anticipate that with a leveraged buyout that the return generated on the acquisition will more than outweigh the interest paid on the debt, resulting in a solid way to see high returns while risking only a small amount of capital.
When to Consider an LBO
When a business owner is thinking about selling, an LBO may be a smart option in several scenarios. In these situations, the owner would like to:
1. Realize the best possible price for his or her business;
2. Continue to operate the business but gain a large amount of cash from the business now to diversify personal assets;
3. Hand the business to family members or a management team when the next generation doesn’t have sufficient capital to pay the owner the company’s full value; and
4. Grow the company, which will require capital but doesn’t want to invest and risk much of his or her net worth (with so much already in the business).
What Type of Companies Are Good Targets for LBOs?
Because the buyer will put a large amount of debt on the company, one of the most important attributes that makes a company a wise target for an LBO is that it’s stable and can pay off its future debts. If not, it will likely default and go into bankruptcy.
That said, here are some types of companies that make good targets:
* Those with stable, strong cash flow;
* Ones with low debt levels;
* Non-cyclical businesses;
* Those businesses with large economic moats’
* Companies that have strong existing management teams;
* Companies with a large asset base that can be leveraged for collateral; and
* Distressed companies that are in good industries
In addition, there are those private equity firms that are seeking to “turn around” troubled assets or looking to purchase an asset with the aim of selling it for a better price in the future.
The private equity firm will then sell off portions of the target company or the company in its entirety—or use its future cash flows to pay off the debt and exit at a profit. Because the debt that’s used to purchase the business will be on the books of the target company rather than the PE firm (sponsor), any debt that’s paid down becomes equity when the company is sold.
How Does the Purchase by a PE Group Increase the Company’s Value?
When a private equity group buys a business, it will either hold the company and allow it to continue operating in the same manner or pursue operational improvements.
Operational improvements may entail things like replacing the company’s management team, selling off assets to free up value, or purchasing more assets to make the core business more efficient. These efforts are designed to increase the company’s profitability or expand the value of the business.
LBOs Take Time
LBOs are often complex and take some time to complete. Address LBO issues with an experienced business advisor like Sacramento’s Andrew Rogerson. He’ll help guide you to a safe transactional conclusion with experienced and careful planning, as well as thorough due diligence.