Leveraged Buy-Out
A leveraged buyout involves purchase of a
company or its division through borrowing. The acquisition
is basically through cash and is funded mainly from sale
of debt and the balance by equity and hybrid securities
secured either from individuals, institutional investors
or commercial banks.
A Typical LBO Operation
A typical LBO operation may be divided into
4 stages.
Stage I
This stage consists of raising cash for the
buyout and devising a management incentive system. An investor
group headed by the company’s top managers and/or the
buyout specialists generally invest 10% of the total cash
required as equity. Outside investors provide the remainder
to the equity. The managers also receive incentives and
compensation in the form of stock. This increases the equity
shares of the management (directors excluded) to 20-30%.
About 50%-60% of the cash required is raised through loans
from banks and financial institutions. The rest of the debt
can also be raised with insurance company or limited partnerships
that specialise in venture capital investments, leveraged
buy-outs, through private placements or from public offerings
such as bonds.
Stage II
The money mobilized in stage I is used by
the organising sponsor group, to buy all the outstanding
shares of the target company either in a stock-purchase
or an asset-purchase format and to make it private. In cases
where the sponsor group buys the assets in an asset-purchase
format, a new business unit is exclusively incorporated
to complete the acquisition. In cases where the new owners
wish to reduce the debt by paying a part of the bank loan,
they sell off a part of the corporation.
Stage III
The motivated managers, with a view to increasing
profitability, manage the assets bought. The management
tries to reduce operating costs by altering marketing strategies,
reorganising production facilities, improving inventory
control, accounts receivable management, changing product
mix and pricing. Other strategies include laying off employees
and reducing the expenditure on research and development.
Stage IV
Once the target profitability is achieved
and the company emerges stronger, the company can go public.
This can be said to be a reverse LBO often referred to as
second initial public offering. Such reconversion into a
public ownership creates liquidity for the existing shareholders.
