Definition of Leveraged buyout
A leveraged buyout is the acquisition of an asset or company which is paid by a significant enough amount of borrowings.
In this sense, there are two kinds of leveraged buyouts:
LBO (Leverage Build Out)
Acquisitions in which the leverage come from the acquired company. This company and its assets are the guarantee for the loan. In this transaction debt to equity ratio can be especially high (between 4 and 12).
LBU (Leverage Build Up)
Acquisitions in which the leverage come from the acquiring company.
Definition of Leverage Ratio
A leveraged ratio is a financial ratio to measure how much capital comes from debts or loans in a company. It can be considered a way to assess the capability of the company to afford its financial obligations.
There are different ratios to measure the company leverage, but maybe the most important is which could be also call debt to equity ratio, which is calculated as:
Total debt / Total Equity
High values in this ratio indicates that the company is largely leverage.
A value higher that 2 indicates a risky scenario for the investor.
To be acquired by a LBO it is necessary that…
- … the target company had enough and steady cash flows.
- … the target company was steady and has a low growth level.
- … the target company had steady and capable managers.
- … it was possible to reduce the target company costs.
- … the target company board was also stockholders.
- … the target company leverage level was low.
- … it was possible to sell assets from the target company.
To be target on a LBO a company should:
- Be a mature company.
- Have enough and steady cash flows.
- Be resistant to economical recessions.
- Have solid assets.
The usual targets in LBO process are:
- Family business changing.
- Subsidiary of multinational companies which are not considered as strategic and could be sold to obtain cash.
- Conglomerate business which could be sold to obtain cash.
Types of LBO
| LBO | It is the general case.
This type of operation is performed by groups of investors or companies that have nothing to do with the company to acquire. |
| MBO or LMBO | Management Buyout or Leveraged Management Buyout and (LMBO). Purchase by management or leveraged buyout by management.
This type of operation implies that the group of investors or purchasers is formed by the directors of the company to be acquired. LBO particular case. |
| LEBO | Leveraged Buyout Employee. Leveraged purchase by employees.
In this case, the buyer group consists of workers or employees of the company to be acquired. LBO particular case. |
| MBI | Management buy-in. LBO of a company by a group of managers financed with debt. These managers may be related or not with the company.
Therefore, the MBO is a particular case of MBI, since the directive in the MBO acquired by the company itself belonging to the company to acquire. |
| BIMBO | Buy-in Management Buyout. It is the combination of a MBO and a MBI, ie, there are executives from the company and others to acquire the firm using leveraged buyout. |
Leveraged Buildup (LBU)
In such acquisitions, debt comes from the buyer or acquirer.
These acquisitions are different from the LBO because the aim consist in from a company (company platform) or starting from nothing, to grow and acquiring companies through debt as a way of financing the purchase of the acquired company.
The objective is that the company will increase its size until you have the optimal size.
However, the LBU is considered more risky than the LBO by potential creditors.
LBU Key Elements
- Solvent management team: Experience, contacts from different sectors.
- Solid group of investors: Enough equity or own resources.
- Sector with good prospects: A fragmented sector without large enterprises, with options to achieve economies of scale that constitutes the competitive advantage of the company arising through the LBU.
- Management Information System: A system that allows to control and integrate new acquisitions in areas such as accounting, inventory, control of financial statements, the audit, finance, etc.
- Simple Capital Structure: The lower number of lenders and the more stable group of shareholders, more easily financed and therefore controlled such operations; or consequently, the more successful the LBU.
En colaboración la Dra. Inés Martín de Santos.