LEVERAGED BUYOUT

INTRODUCTION
A Leveraged Buy-Out can be defined as a transaction in which
group of private investors, typically including management, purchases a
significant and controlling equity stake in a public or non public
corporation or a corporate division, using significant debt financing,
which it raises by borrowing against the assets and/or cash flows of the
target firm taken private.

CONCEPT
In a leveraged buyout, a company is acquired by a specialized
investment firm using a relatively small portion of equity and a
relatively large portion of outside debt financing.
The assets of the acquired company are used as collateral for the
borrowed capital, sometimes with assets of the acquiring company.
Typically, leveraged buyout uses a combination of various debt
instruments from bank and debt capital markets.

CHARACTERISTICS OF LBO
 Primary high debt
High debt often implicates high interest payment and hence
LBO transaction prefers mature company which has stable cash flow
generation.

 Incentive and private ownership

During the period of LBO, company would be private
ownership, even though it used to be the listed stock company, their
stock would be stopped trade. After a few years, PE funds would
consider to exit, company going public again, trade sales, and merger
& acquisition are normally chose as “happy ending” of LBO
transaction.
MOTIVATION/RATIONALE FOR LBO
 Tax shield
If company has more debt, they would gain more tax benefit.

 Conglomerate discount
It provides sufficient financial support and high quality
management team to company for business division development.

 Free cash flow

Each company needs free cash flow to support new profitable
project, when company is impossible to gain internal financing, debt
will be the optimal choice due to cheaper cost.

STAGES OF LBO
Initial stages
 Identification of investment funds.
 Construction of an in-house team with all the required
competencies.
 Meeting between management team and selected investment
fund.

After the fund has been selected

 Construction of business plan through an iterative consultation
procedure.
 Refinement and computation of acquisition price parameters
 Definition of target valuation range.

Post-valuation
 Financial engineering and search for the right equity-debt mix on
basis of valuation range and cash-flow and EBIT forecasts.
 Search for lead bank to manage debt syndication.
  Debt packaging and structuring into senior debt and mezzanine
debt.
 Negotiation of lending rates with banks.

Negotiation with seller

 Negotiation, usually via a bank.
 Agreements on acquisition price and financial arrangements
 Signing of deal at the “closing” meeting.

LBO CANDIDATE CRITERIA

Specific criteria for a good LBO candidate include:
 Steady and predictable cash flow
 Divestible assets
 Clean balance sheet with little debt
 Strong management team
 Strong, defensible market position
 Viable exit strategy
 Limited working capital requirements
 Synergy opportunities
 Minimal future capital requirements
 Potential for expense reduction
 Heavy asset base for loan collateral

SUCCESSFUL FACTORS FOR LBO

Successful LBO depend on some key factors such as
 The prospect firms of LBO only focus on mature companies who
have steady cash flow generation but few profitable opportunities
for long-term development.
  LBO candidates should be checked by financial statement, in
order to figure out whether company has capability to fulfill debt
obligation.
 Furthermore LBO target firm should hold tangible assets much
more than intangible, because company with a lot of tangible
assets could be gain more tax benefit from high debt capital
structure, and tangible asset would be much easier to sell under
any buyout intention.
 A qualified management team is another crucial factor for a
successful LBO. Because managers’ diligence would positively
affect company financial performance which is relative to sustain
stable cash flow for high interest payment and debt obligation
 The selection of exit strategy is relative to managers’ diligence
effect as well, there are many ways to exit LBO transaction

NEGATIVE IMPACT OF LBO

 The most obvious risk associated with a leveraged buyout is that
of financial distress.
 Weak management at the target company or misalignment of
incentives between management and shareholders can also pose
threats to the ultimate success of an LBO.
 Leverage can induce firms to choose overly risky projects as they
Over-optimistically forecasts of the revenues of the target
company
 In addition, an increase in fixed costs from higher interest
payments can reduce a leveraged firm’s ability to weather
downturns in the business cycle.
 Too much debt would bring high interest payment, and company
would be much easier to meet financial distress or bankruptcy in
this kind of capital structure.