Can someone tell me what a leverage buy out is?

Question

Can someone tell me what a leverage buy out is? From what I understand your basically using the assets and cash flow of the business u want to buy, as collateral for a loan? Why doesn't everyone just do that then? What is required to get a LBO? I see a oil field construction business in alberta for sale, very heavy in assets and inventory. Business grosses over 2M a MONTH and cash flow of over 4M a year. Now would a business like that be something you could use an LBO for? Tons of assets and massive cash flow seem to be the most significant factors, no?

Answer 1

Read up on it, it's not a simple as you might think...

http://en.wikipedia.org/wiki/Leveraged_buyout



Keep in mind, to buy the company you have to buyout all or the majority of the outstanding equity shares. A company's market capitalization (#of outstanding shares times market price of the stock) is often significantly in excess of the book value of the company's assets, so leveraging the assets alone won't usually provide you with enough funds. You have to find a lender willing to lend based on the cash flows you expect the company to produce - and you'd better have a plan to improve those cash flows over the existing cash flows.



From the above link...

Companies of all sizes and industries have been the target of leveraged buyout transactions, although because of the importance of debt and the ability of the acquired firm to make regular loan payments after the completion of a leveraged buyout, some features of potential target firms make for more attractive leverage buyout candidates, including:

Low existing debt loads;

A multi-year history of stable and recurring cash flows;

Hard assets (property, plant and equipment, inventory, receivables) that may be used as collateral for lower cost secured debt;

The potential for new management to make operational or other improvements to the firm to boost cash flows, such as workforce reductions or eliminations;

Market conditions and perceptions that depress the valuation or stock price.



Hope this helps...

Answer 2

>>Can someone tell me what a leverage buy out is?



Wiki has a fine articel on leveraged buy-outs http://en.wikipedia.org/wiki/Leveraged_buyout



>From what I understand your basically using the assets and cash flow of the business u want to buy, as collateral for a loan?



That's a large component of all LBO's but there is usually an equity component in it as well. Wiki points out that debt usually comprises about 2/3 of the financing for most LBO's. It's tough to get lenders to lend you all the money for the acquisition without you convincing them that you have "skin in the game".



>Why doesn't everyone just do that then?



Because finding the right target is difficult. Assembling the financing is difficult. Having the vision and ability to change the way the company is run so that it can service the enormous debt burden is difficult. If the world is right, a company is run so that it has something like an optimal debt/equity ratio (people study corporate finance to learn how to figure out what that is). After an LBO, there is almost always much more debt so the company needs to be transformed into a company whose optimal capital structure is that dictated by the new debt/equity mix. That's a tough job and sometimes can't be done. Then there's a whole heap of trouble if the company defaults on the debt as the LBO can be challenged as a "fraudulent transfer".



>What is required to get a LBO?



Pretty much you need to be a company that does this for a living like Blackstone or KKR. These companies have their own capital, lots of connections for borrowing, and expertise on running and modifying the company.



>Now would a business like that be something you could use an LBO for?



Cash flow and real assets are important for an LBO, no doubt about it because both are useful for procuring debt. Of course, solid assets and reliable cash flow make a business expensive so it might simply be too pricey to buy. A perfect target for an LBO is a company that does not achieve the cash flow that it could and has underutilized or undervalued assets. A private equity firm examines such a company and will identify assets that can be sold off, and assets that can be managed differently to produce large cash flows that pay the debt. What's left of course accrues to the firm.

Answer 3

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