What is a Leveraged Buyout?
LBO stands for Leveraged Buyout, referring to a company's acquisition while primarily using debt to fund the transaction. Usually, leveraged buyouts are made by private equity companies and gained prominence in the 1980s. They have become more popular because they don't require a high amount of up-front capital. The defining feature of an LBO is that the debt of the target company is secured by its assets, and cash flow can be used to pay for the cost of financing.
At Bovell Financial, we can guide you through the leveraged buyout process and show you how to make large acquisitions without tying up a lot of capital. Contact us today to discuss your financing and acquisition goals!
3 Main Reasons to Conduct a Leveraged Buyout
What Kind of Companies are Good Candidates for LBOs?
When looking to purchase a company with a leveraged buyout, you must perform due diligence before sealing the deal. The company should have a strong cash flow, a good management team, and a large asset base to use as collateral. Companies with a positive balance sheet and a diverse, loyal customer base will be more attractive to lenders and less risky for the buyer or investor.
If a company is struggling because of industry recession or poor management, they could still be good candidates for a leveraged buyout if they have a positive cash flow. These circumstances may provide an opportunity to create efficiencies and improve the business and sell it for a high profit.
Advantages of a Leveraged Buyout
Financial buyers will want to analyze each opportunity by measuring the internal rate of return (IRRs), which is the expected compound annual rate of return on the investment. Calculating the IRR can be done using a dedicated spreadsheet program or a financial calculator and used for investment analysis. The goal of an LBO is to use as little equity as possible and repay as much debt as possible over a five to ten-year period to create a significant increase in the equity return. The rate of return can be as high as 20-30% with an LBO versus the 5-10% rate of return of just the business on its own.
Factors Driving LBO Returns
Creating value in leveraged buyouts is driven by specific factors such as paying down the debt, operational improvement, and buying low and selling high. The debt-to-equity ratio is a significant factor in determining the rate of return and should be at 70% debt to 30% equity. Debt is cheaper than equity, so the more debt used in the transaction, the higher the internal rate of return (IRR) will be at the end of the transaction.
Interested in a Leveraged Buyout?
As with any business decision, it is important to weigh the pros and cons of the investment and have a strong handle on the financials. This allows you to think clearly about the issues and how they may be solved to improve a deal. Bovell Financial can help you get ready for a leveraged buyout, guide you through the process, and perform the due diligence required to make the investment worthwhile. Contact our expert team today and find out how we can help with leveraged buyouts in Manhattan.