The LBO (Leverage Buy Out), an often complex financial operation, is a technique for taking over a business, which depends on “leverage.”
In this operation, the funds serving the business takeover come from the capital of that same business. Thus the business mangers or other interested parties have the opportunity to take control of the business by means of a minimum personal contribution. The rest of the operation is then financed by bank loans whose cost should always be less than the rate of return of the entire operation.
In France, the RES, namely the acquisition of a company by the employees, is a particular form of LBO.
The Function of the LBO
First off a holding company is made by the stockholders, who thereby become majority stockholders in the company from the beginning. The prophets made by the company will go up to the holding company and will therefore allow them to repay the banks any debts generated by the operation. In other words, so that leverage can occur, the investment should be sufficiently profitable so that it brings in more money than the total interest on bank loans.
This operation presents a great advantage for businesses hoping to improve the profitability of their investments; they are also often large groups composed of investment funds which, together with business managers of the company, will perform the takeover with capital often not worth even half value of the company.
The amount borrowed to finance the operation will be reimbursed by the rise of the company’s dividends.
One should note that today this operation represents the majority of operations carried out by investment funds, and that it is one of the most apt at allowing the transfer of a family business because it authorizes a natural or legal person to become owner of the business with limited resources. It has also been seen that companies who used the process have benefitted from it, showing 3% annual growth.
Securitizing the LBO operation
However before implementing such an operation, one should verify that the society for which the LBO will be put in place is in good financial health, and that it has established continuity or is evolving in a stable manor. It is also worth noting, that in case a problem occurs during the operation, the resulting negative consequence will be that any loss falls onto the investor’s funds.
This way of financing whereby the acquisition of the business is done directly “from the inside” is a solution that comes straight from our Anglo-Saxon neighbors, not only solving problems within large businesses, but those within smaller businesses, and particularly those suffered by PME’s.
With all this in mind, it is wise to remember that the intervention of highly qualified business lawyers is essential to succeeding in these complex, but interesting cases.