During the due diligence stage these factors are taken into consideration to ensure value is created for the target LBO candidate. The principle goal of the acquirer is of debt repayment hence they would not want to make large capital expenditures in order to keep the business growing. In situations where high Capex is incurred it consumes cash which would have been otherwise used for interest and principle debt repayments.
Further their needs to be a differentiation made at the due diligence stage between the kind of Capex viz. Knowing about these factors in advance would help in planning the cash outflows. A target company with low debt would mean few commitments to pay off the loans. If the company already has debt on its balance sheet, it would make the deal risky as there is already cash outflow.
This situation would make it challenging for raising more debt which is a requirement for the leveraged buyout. Therefore for a good leveraged buyout there is a requirement of a candidate with no or little existing debt so that the cash flows can be primarily used to pay off the principal and interest due on the debt to be taken. Is it important that the target business has products which are well established in the market and keeps generating cash flow to maintain a good position in the market.
This will make sure that the target company will not be affected after the LBO and make the cash flows less prone to risks. The factors that reflect strong market position could be rooted customer relationships, superior quality products and services, good brand name and recognition, suitable cost structure, economies of scale etc.
Based on these factors the sponsor and the acquirer would decide if the target has a secure market position. Divestible assets include equipment, machinery, land etc.
Similar to assets the seller could sell out the investments, non-core business divisions and subsidiaries to generate quick cash. This cash could also be used to reinvest with newer strategic objectives.
But of course it has to be taken into consideration that such investments and assets should not be a significant contributor to the income of the company. Companies that are a part of the established and definite markets are considered to be more favorable for an LBO transaction rather than those belonging to the novel markets.
Stability plays an important role as there are predictable demand and revenue which acts as a barrier to potential entry into the market signifying non-disruptive cash flows.
Businesses with a good management team are very attractive and valuable LBO candidates. When it comes to a highly leveraged capital structure with rigid performance targets require talented people with a successful track record. Management which has a prior experience of incorporating restructuring activities would be highly acknowledged by the sponsors and acquirers.
In cases where the existing management team lacks efficiency the acquirers would make certain important changes by adding, replacing or deleting certain members and make a new team altogether. Whatever may be the situation having a strong management team is a pre-requisite for a good LBO transaction.
The basic objective of an LBO is to get significant returns on the investment made, which comprises of selling the company few years down the LBO took place. Hence it becomes important to determine if the business could be sold at a higher multiple than at the time of entering the deal. There are certain ratios that aid in the search of a good leverage buyout candidate. Finally, if the target company is privately held, the seller could realize tax advantages from the LBO. In a n LBO, the same leverage that allows greater reward also comes with greater risk.
Depending on how the buyer defines risk and how risk-tolerant he or she is, this could be attractive or it could be a source of anxiety. The risks of a leveraged buyout for the target company are also high. Interest rates on the debt they are taking on are often high, and can result in a lower credit rating.
LBOs are especially risky for companies in highly competitive or volatile markets. Aside from risk, there are several criticisms of leveraged buyouts that are worth considering.
Because the company will often focus on cutting costs post-buyout in order to pay back the debt more quickly, LBOs sometimes result in downsizing and layoffs. They can also mean that the company does not make investments in things like equipment and real estate, leading to decreased competitiveness in the long term.
Another criticism of LBOs is that they can be used in a predatory manner. One way that this happens is when management of a company organizes an LBO to sell it back to themselves and gain short-term personal profit.
Predatory buyers can also target vulnerable companies, take them private using an LBO, break them up and sell off assets — then declare bankruptcy and earn a high return.
This is the tactic private equity firms used in the s and s that led to leveraged buyouts garnering a negative reputation. To truly understand leveraged buyouts , you can take a look at examples of both beneficial and failed LBOs. They purchased Chewy. The buyout was funded mostly with debt and the agreement that Safeway would divest some assets and close underperforming stores. Hilton Hotels Leveraged buyouts can be successful in economic downturns. The economy plummeted and travel was especially hard-hit.
Blackstone initially lost money, but it survived thanks to its focus on management and debt restructuring. However, they did eventually bounce back, enjoying profitability for several decades before falling sales recently led to more troubles — this time not related to leveraged buyouts. There are five typical phases in the life cycle of a business. Knowing which phase your company is in can help you decide whether a leveraged buyout is the right option or if you need to postpone selling.
This is the stage where you hone your offerings and attempt to make your business talkably different. Some business owners are able to extend this stage of the cycle by using constant strategic innovation or entering new markets.
LBOs provide a means of exit that is realistic for many companies. Thinking about selling your company through a leveraged buyout? This means you have things like tangible assets, good working capital and positive cash flows. Having a positive balance sheet means lenders are more likely to lend to you. Firms looking to acquire companies through a leveraged buyout typically also look for proven management and a diverse, loyal customer base.
Companies that may be struggling due to a recession in their industry or poor management but still have positive cash flow are also good LBO candidates. Investors may see an opportunity to create efficiencies and improve the business and therefore be interested in acquiring it.
Making the decision to consider a leveraged buyout of your company is not something to be taken lightly. How will you feel once you sell? A business coach can look at the prospect objectively and without the emotion that you as the business owner will bring to the decision.
With their help, you can make a solid decision that is best for your future. Despite some bad press in recent years, a leveraged buyout is a viable exit strategy in many situations. As with any business decision, weigh the pros and cons before making your decision. The buyer can be the current management, the employees, or a private equity firm. It's important to examine the scenarios that drive LBOs to understand their possible effects. Here, we look at four examples: the repackaging plan, the split-up, the portfolio plan, and the savior plan.
The repackaging plan usually involves a private equity company using leveraged loans from the outside to take a currently public company private by buying all of its outstanding stock.
The buying firm's goal is to repackage the company and return it to the marketplace in an initial public offering IPO.
The acquiring firm usually holds the company for a few years to avoid the watchful eyes of shareholders. This allows the acquiring company to make adjustments to repackage the acquired company behind closed doors. Then, it offers the repackaged company back to the market as an IPO with some fanfare. When this is done on a larger scale, private firms buy many companies at once in an attempt to diversify their risk among various industries.
The remainder is funded through their own equity. Those who stand to benefit from a deal like this are the original shareholders if the offer price is greater than the market price , the company's employees if the deal saves the company from failure , and the private equity firm that generates fees from the day the buyout process starts and holds a portion of the stock until it goes public again.
Unfortunately, if no major changes are made to the company, it can be a zero-sum game , and the new shareholders get the same financials the older version of the company had. The split-up is considered to be predatory by many and goes by several names, including "slash and burn" and "cut and run.
This scenario is fairly common with conglomerates that have acquired various businesses in relatively unrelated industries over many years.
The buyer is considered an outsider and may use aggressive tactics. Often in this scenario, the firm dismantles the acquired company after purchasing it and sells its parts to the highest bidder.
These deals usually involve massive layoffs as part of the restructuring process. It may seem like the equity firm is the only party to benefit from this type of deal.
However, the pieces of the company that are sold off have the potential to grow on their own and may have been stymied before by the chains of the corporate structure. The portfolio plan has the potential to benefit all participants, including the buyer, the management, and the employees. Another name for this method is the leveraged build-up, and the concept is both defensive and aggressive in nature. In a competitive marketplace, a company may use leverage to acquire one of its competitors or any company where it could achieve synergies from the acquisition.
The plan is risky: The company needs to make sure the return on its invested capital exceeds its cost to acquire, or the plan can backfire. If successful, then the shareholders may receive a good price on their stock, current management can be retained, and the company may prosper in its new, larger form.
The savior plan is often drawn up with good intentions but frequently arrives too late. This scenario typically includes a plan involving management and employees borrowing money to save a failing company.
The term "employee-owned" often comes to mind after one of these deals goes through.
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