Pros and Cons of Leveraged Buyouts

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You’ve built a strong business, but it’s time to start thinking about leaving it behind to pursue the next chapter of your life. With all the work you’ve put in, shuttering the enterprise isn’t an option.

If selling sounds like a good option, you will likely run across an investor who offers leveraged buyouts. More than $1 trillion in leveraged loans were used in 2019 to buy businesses. It can be a good way to cash out of your business and get the reward for all the hard work you’ve put in.

Let’s take a look at the leveraged buyout model and how to make it work for you.

What Is a Leveraged Buyout?

Leveraged buyouts involve buying a company using mostly debt or leverage. The debt is secured with the assets of the company being acquired, usually cash flow but also hard assets. The acquired company assumes the debt going forward.

The typical ratio for these deals is 90 percent debt to 10 percent equity, which is posted by the buyer. In that way, it’s a bit like when you buy a house and put 10 percent down and borrow the rest from the bank.

As a simple leveraged buyout example, you would buy a company for $100 million. You would borrow $90 million and put up $10 million of your own cash.

LBO Pros

Leveraged buyouts offer a lot of benefits, starting with the fact that there is very little risk to the buyer. You don’t have to put up all the cash to buy the business, while the company you’re buying owes the rest instead of you. Your personal finances are safe if the deal should fail.

An LBO can provide an excellent rate of return on your equity if things go well. It creates value for the firms’ shareholders and facilitates wealth transfer and creation.

Smaller businesses benefit through increased company capitalization and improved market position. In an LBO driven by management or employees, there can be increased commitment and productivity because they have a greater stake in the company. The company even benefits because it’s a debt-driven transaction, which can lead to some tax advantages.

LBO Cons

The largest con to an LBO is that it saddles your new asset with a ton of debt – almost the value of the company — and that can strain its profitability and cash flow. It explains why companies acquired with leveraged buyout financing are more likely to go bankrupt than others.

The debt load is particularly dangerous for companies vulnerable to industry competition or economic volatility. If the cash flow and sale of assets isn’t enough to meet interest payments, it’s likely to fail, which can mean problems for employees and suppliers.

Ready To Make a Move?

When it’s time to move on from your business, a leveraged buyout by a private equity firm can provide a way to get your hard-earned reward. Leveraged buyouts can be a simple means of selling your business and a good deal all around as long as your business has a healthy bottom line.

If you need help with a buyout or other business consulting, contact us to discuss your options and how we can help.