What is a leveraged buyout?
Have you been thinking about your business exit strategy? You’ve probably considered multiple options, from initial public offerings to liquidation. But if you’re like many business owners, simply shutting the doors for good isn’t what you had in mind when you started your company. As Tony Robbins says, “business is for gladiators.” You put in the hard work, and you deserve a reward.
Whether your business is at peak performance and you want to capitalize, or you’re thinking about retirement, a buyout could be a good option for you. In particular, leveraged buyouts provide a means of exit that is realistic for many companies.
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What is a buyout?
A buyout, as a general financial term, is when one company acquires all or a majority of the stock of another company. The company that acquires the stock is the buyer; the company that sells its stock has been “bought out.” This gives the buyer controlling interest – that is, the majority vote within the company. As you can imagine, this gives the buyer massive influence, which is typically their goal.
What is a leveraged buyout?
A leveraged buyout is when one company acquires another using a significant amount of financing, meaning the buyout is funded with debt. The company doing the acquiring, typically a private equity firm, will use its assets as leverage. The assets and cash flows of the company that is being acquired (called the target company or seller) are also used as collateral and to pay for the financing cost.
Why are leveraged buyouts used?
Leveraged buyouts are often part of a mergers and acquisitions (M&A) strategy. They’re also sometimes used to acquire the competition, and to enter new markets to help a company diversify its portfolio. Buyers like leveraged buyouts because they don’t have to put in very much of their own money, allowing them to report a higher internal rate of return (IRR). In short, leveraged buyouts allow firms better equity returns.
Why would a target company want to sell via a leveraged buyout? It’s actually a relatively common method for selling a business. The seller will be able to get the price they want for the business, and will have a way to exit the company with a solid plan in place. Leveraged buyouts are an ideal exit strategy for business owners looking to cash out at the end of their career.
What are some examples of leveraged buyouts?
There are several different scenarios for carrying out a leveraged buyout. One of the most common is to take a public company private. Often, a private equity firm will acquire all of the stock of a public company in a leveraged buyout. This means the public company is now private – temporarily. The firm will then take the company public again in hopes of earning huge profits.
The public-to-private scenario can also be used by the target company’s own management. In that case, the current management buys its own stock, does not take the company public, and continues to operate it as a private company.
Another common scenario is acquiring a competitor. Leveraged buyouts allow smaller companies to acquire their larger competition – and grow dramatically. Buying a competitor can help the smaller company enter new markets, gain new customers and be able to scale quickly.
What are the advantages and disadvantages of leveraged buyouts?
The advantages to the buyer are clear: They get to spend less of their own money, get a higher return on investment and help turn companies around. However, there are also risks to the buyer. The same leverage that allows greater reward also comes with greater risk – like many things in life. There is little margin for error, and if they’re not able to pay back the debt, they’ll get no return at all.
For the seller, one of the main advantages of leveraged buyouts is the ability to sell a business that might not be at its peak performance, but still has cash flow and the potential for growth. This type of buyout also allows groups such as employees or family members to acquire the company, if, for example, the current owner is retiring. One final benefit: If the target company is privately held, the seller will be able to defer capital gains taxes.
The risks of leveraged buyouts for the target company are also high. If they’re unable to service the debt, the end result is bankruptcy. This is why it’s important to consider all the pros and cons of leveraged buyouts before signing on the dotted line.
Is my company a good candidate for a leveraged buyout?
Thinking about selling your company through a leveraged buyout? If your business has a positive balance sheet, you’re on the right track. 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 leveraged buyouts typically also look for proven management and a diverse customer base. They’ll want to see ways to reduce costs quickly, selling off non-core assets or finding synergies.
Your company doesn’t have to be operating at maximum performance in order to be a good candidate. Companies that may be struggling due to a recession in their industry or poor management, but still have positive cash flow, are good candidates for leveraged buyouts. Investors may see an opportunity to create efficiencies and improve the business.
Despite some bad press in recent years, leveraged buyouts are a viable exit strategy in many situations. As with any business decision, weigh the pros and cons before making your decision. With a little intuition and a lot of research, you’ll make the right choice and see the rewards – both personal and financial – you’re looking for.
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Learn about the advantages and disadvantages of a leveraged buyout, along with other exit strategies, with Tony Robbins’ 7 Forces of Business Mastery free content series.