Adopting a Leveraged Buy-In (LBI) Approach to Acquire a Business
What is a Leveraged Buy-In and Leveraged Buy-Out?
A Leveraged Buy-Out (LBO) is the acquisition of Target Company for sale by an Acquiring Company where they use a significant amount of borrowed money to meet the cost of acquisition. A Leveraged Buy-In (LBI) is a term used when an external team seeks to undertake an LBO, so in reality, they provide the same meaning.
The assets of the Company being acquired are often used as collateral for loans, along with the assets of the acquiring Company. The purpose of Leveraged Buy-Out/In is to allow Companies to make acquisitions without having to commit a lot of capital.
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An LBO transaction typically occurs when a Private Equity (PE) firm borrows as much as they can and finances the balance of the deal with very little equity and deferred payments. Acquirers of Businesses use the LBO approach for two main reasons;
‣ To minimise their own cash being injected.
‣ To achieve the maximum return on any investment the acquirer makes by using other sources of finance to fund the deal, together with deferred payments. This idea came from the USA.
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Main Risks of a Leveraged Buy-Out:
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‣ Prior to the LBO occurring, the debt repayments now in place to pay for the shares did not exist. Now they do exist, post the LBO deal. This increases the risk of the Target Company being acquired to become insolvent i.e. unable to pay its debts as and when they fall due. Increased monthly debt repayments can have an adverse effect on the Target Company being acquired due to the increase in break-even point and consequential reduction in cash at bank.
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‣ The Directors of the Target Company and of the Acquiring Company, should produce a board minute and statement which states their approval to the LBO deal and that in their opinion, based upon their financial forecasts, the deal and debt burden should not destabilise the Target Company going forward.
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‣ The Directors of the Target Company and of the Acquiring Company have a legal “Fiduciary” duty under the Companies Act to make decisions in the best interest of all Shareholders (current & future) and the Company itself and its Creditors. Therefore, the LBO deal structure needs to be carefully crafted by all parties to ensure the debt and deferred payments burden does not push the Company into a state of distress.
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Conclusion
In theory, LBO’s are here to stay and they are a perfectly acceptable method of acquiring the shares in a Company. The only caveat is the need for great caution to be undertaken, regarding the deal structure and margin of safety over and above the break-even point and cash at bank requirements on the part of the Target Company’s Directors and on the part of the Acquiring Company’s Directors. All Directors involved should seek the advice from a professional and experienced accountant and corporate lawyer on the LBO deal. HMRC would also be a good point of contact on the deal structure proposed.
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To help visualise a Leveraged Buy-In please click on the following PDF link:
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