Few people who work for small companies realize how easy it can be to buy the businesses that now employ them by using a leveraged buyout (LBO).
An LBO is a term the financial community uses to describe the sale of a company to a buyer—usually an executive or manager of the company—who puts up little or none of his own money. Instead, the buyer uses the company’s assets as collateral for a loan. This borrowed money is then used to pay the seller.
The idea really isn’t that much different from taking out a mortgage when you buy a house. In that case, a bank lends up to 90% of the value of the home.
In an LBO, the lender is paid back out of the company’s after-tax profits. For that reason, the lender looks for a buyer in whom it has the confidence to keep the company profitable.
Are You A Good Candidate?
Lenders look for people who know their businesses inside and out. Professionals who can steer the company through critical periods of new management and massive debt. If your track record shows that you can, lenders will look at your personal credit history and stability next. Even if you are highly successful in your career, lenders may shy away from you if you seem to find your way into unmanageable debt or have a history of changing jobs often.
You can score big points with lenders by showing them how the company, under your management, can generate bigger profits than it is currently making.
How To Start
Before looking for a lender, you must find a company that you’re interested in buying. If you’re a real pro in your field, you’ll probably know whether the company you work for is for sale. If it is not, you may know of similar ones that are.
Once you find a company for sale that is of interest to you, carefully go over its financial statements to determine whether an LBO is possible. The effort will usually require the assistance of an accountant, preferably one who has substantial experience in LBOs.
In general, lenders who finance LBOs let you borrow up to about 75% of the company’s accounts receivable plus around 25% of the inventory. But paying the loan back at the current LBO rate of about 12% will put a significant burden on the company’s cash flow.
For that reason, even though a company may have the collateral for a loan, it still may not be a good LBO candidate if it is going to need large capital expenditures in the near future.
Example: A printing business that is doing very well—but whose presses will soon have to be replaced.
That’s where your expertise comes in. As a professional with a successful track record in your field, you’ll be in an excellent position to forecast future business and project how the company can make it without big expenditures while the loan is being repaid.
Obviously, however, few people are experts in all areas of a business—production, marketing, finance, etc. So to prove to a lender that all these areas will be in competent hands, you need to assemble a strong team to help you steer the business through the critical period.
These people can come from the company’s current management ranks, or you can bring in professionals from other companies.
Until the loan is repaid—generally within three to five years—the management by you and the other members of the team will be under constant scrutiny by lenders. The lenders usually insist on rigorous auditing requirements that will put an extra burden on management.
Finding A Lender
LBOs are typically financed by banks, venture capital groups, brokerage houses, commercial finance companies and factors (specialists who deal in accounts receivable).
It is often best to turn first to a banker who knows the company and you. If the bank isn’t interested in an LBO, it can usually point you to venture capitalists or other groups who may be in the market for what you have to offer.
Though your contribution to an LBO deal is management skill, lenders will want you to put down some cash. That doesn’t have to come out of your pocket because you may be able to borrow the additional amount in exchange for a part interest in the company.
Recent case: A knowledgeable buyer with whom we worked was able to get $14.5 million in financing for a $15 million buyout, but the lenders wanted him to put up $500,000. To get the cash, we went to a group of venture capitalists, who agreed to a $500,000 loan in exchange for 50% of the company. He had to give up a significant share of the business, but he bought it with none of his own money.
See Also: Look Who’s Getting That Bank Settlement Cash – you can sell your structured settlement to get the cash you need to start your business.
Laura Bushnell is Editor in Chief for National Review Brand Foundation of Consumer Updates and based in Boston. Previously, she held senior VP level positions in corporate finance and consumer financial planning firms.