Leveraged buy-outs LBO

Leveraged buy-outs LBO

In the field of corporate mergers, there are various forms of corporate restructuring, mainly aimed at capturing a larger market share within the type of business of the companies involved in the restructuring.

This article is aimed at analysing corporate takeovers where debt has a major impact on the transaction, which are referred to as leveraged buyouts or LBOs.

WHAT ARE LBO LEVERAGED BUYOUTS? 

Leverage buy-outs are those integration transactions between companies whereby the majority of the financing for the acquisition comes from external agents, so that the level of financial leverage of the transaction is almost entirely the resource used to pay for the sale and purchase.

ADVANTAGES AND DISADVANTAGES 

The main advantage of this type of operation is the almost non-existent level of own resources of the acquiring company, resources that will be used for the acquisition itself and therefore this usually translates into higher returns for the promoters of the operation, normally the parent company of the newco that will be considered as the acquirer.

Notwithstanding the above, the main disadvantage of this type of transaction is the excessive dependence that the acquirer will have on the acquired company, since the latter will be the entity that settles the debt contracted with the financiers. In this regard, it is important to manage the cash flow expectations of the acquired company, as it is precisely these that will favour the repayment of the financial debt.

STRUCTURE OF A LEVERAGED BUYOUT LBO 

This type of transaction involves three distinct parties:

• The acquiring company: this may be an existing company or one set up ad hoc for the transaction (also known as a newco). This company will be the debtor for the purposes of the financing obtained for the transaction. 

• The target company: this is the company that is to be acquired and whose activity will almost exclusively determine the repayment of the debt incurred by the acquiring company. In this sense, the company will “repay” the debt acquired by its newly formed parent company by means of the cash flows generated, flows that are taken to the parent company through the distribution of dividends or capital reductions with the return of contributions.

• The financing company: this is the credit institution that grants the funds necessary for the acquisition (around 80% of the price), in exchange for a series of guarantees that must be provided by the acquiring company. Care must be taken here with the concept of financial assistance, i.e. the target company cannot advance funds or provide guarantees of any kind for the acquisition of its own shares.

FINANCING OF ACQUISITIONS 

As mentioned above, this type of transaction is highly leveraged due to the debt contracted with the corresponding entities. Consequently, around 80% of the sale and purchase is financed by external agents, and the remainder is contributed by the acquiring company’s own shareholders.

LETSLAW BY RSM 

LETSLAW BY RSM has a commercial team with experience in corporate restructuring operations, including leveraged buy-outs, which can assist clients with this type of advisory needs.