Should you fear or embrace a Leveraged Buy Out (LBO)?
Leveraged buy-outs are often referred to as ‘vendor financing’ as the seller participates in the sale of his business by enabling a combination of the business assets and or future cash flows to be used to fund the transaction.
It’s true that there are perceived disadvantages to this format but there are also many real advantages including securing a much higher price verses a cash deal and ultimately achieving a deal in the only way in which a deal may be concluded.
This mechanism is especially relevant given a current world where cash is in short supply, where the Banks will not lend and where there is a vacuum as far a funding for small or medium sized businesses is concerned.
There are also significant tax implications that would encourage a vendor to sell via this type of deal structure that would override any thoughts of delaying a sale until the world becomes more financially buoyant.
So in simple terms, what is a Leveraged Buy-Out (LBO)?
Basically the buyer will offer a price to acquire the business but this offer will be predicated on the buyer re-financing one of, or a combination of e.g. the buildings, the debtor book, the stock and plant or machinery.
By way of an example let take a business with a debtor book of £300,000 and where an acceptable offer is in the region of £500,000. The buyer may seek to raise funds against the debtor book of approximately £250,000 that may be subsequently used as the first up-front payment and then the balance may be paid using the profits generated by the business over the next e.g. 2 years.
This is a very simple structure but in more complex deals the structure will involve various assets and cash payments.
From the vendor’s viewpoint he has a deal in the right financial parameters but the risks he may fear are those associating with guarantees of payment of deferred consideration.
What guarantees can be put in place?
Put bluntly there are rarely any guarantees of payment unless cash is paid upfront on day one. The cost of that cash is of course a large discount on price and in reality even cash buyers want to cover their risks too by deferring payments or making them subject to performance.
Therefore the business risks are about controlling the actions of the buyer when control is taken and this is done through vendor protection clauses in the Sale and Purchase Agreement and where possible security is taken over the other assets of the business.
You should also keep in mind that a cash buyer will put the debt into the business in any event and so the risks of future payment due to leverage may be broadly the same.
So is it true that ‘the buyer is buying my business with my own money?
Yes it is, notwithstanding the buyer has to fund significant deal costs, give loan companies guarantees and of course take on the business legacy.
A more focused question, is "will this deal structure give me everything I need by way of disposing of the business and do I feel sufficiently protected?".
Should you choose a leveraged buy out?
Working with Hyde House and your legal advisers a leveraged buy out can be constructed providing the vendor with not only the desired quantum, but also a workable deal structure and many and various protections within the Sale & Purchase Agreement (SPA).
If you have been presented with an offer based on an LBO deal structure and are unsure whether you should accept please call us today for a free consultation.