LBO, or Leveraged Buy Out », is an effective tool used to acquire a company.It enables an acquisition to be made with a minimum capital contribution in relation to the amount of the acquisition, using debt to the maximum. This maximises the return on equity invested also called « leveraging ».
The operation consists of the buyer, whether a group or an individual, creating a "holding" company that will acquire the shares of the target company. The holding company will then subscribe to a debt from one or several financial institutions, often amortized over 7 years, known as senior debt. This may potentially be supplemented by a bank loan repayable "in fine" and/or the issuance of bonds or other hybrid securities.
Finally, it may be necessary to supplement the capital brought by the buyer to the holding company with an equity contribution from external investors, such as investment funds or business angels, referred to as "sponsors." If the LBO transaction can be carried out solely through the equity investment of the acquirers and/or managers and bank debt, it is called a "sponsorless" LBO.
The debt incurred by the holding company will then be repaid using the cash flows generated by the target company, through the distribution of dividends to the holding, its parent company.
This setup allows the acquisition of a company with minimal capital input, and leverage will help increase the return on invested capital.
Un acquéreur souhaite acquérir une société valorisée 10 M€, qui génère 1,4 M€ de résultat net par an. Il dispose de 3 M€. Il crée une société holding qui achètera 100% de la cible et apporte en capital ses 3 M€ à la holding. La holding souscrit 7 M€ de dette senior sur 7 ans, à un taux annuel par exemple de 5%, ce qui correspond à des échéances annuelles de 1,2 M€ environ. Chaque année, la société cible va verser 1,2 M€ de dividendes à la holding pour que celle-ci rembourse ses emprunts. A l’issue des 7 ans, la holding aura totalement remboursé sa dette. En supposant de façon très prudente que la valorisation de la société cible n’a pas évolué pendant cette période, l’acquéreur détiendra donc 100% d’une société holding, qui possède 100% d’une société cible valorisée 10 M€ et n’a plus de dettes. La holding vaudra donc 10 M€. L’acquéreur aura investi 3 M€ et détient les titres d’une holding qui vaut maintenant 10 M€. Il a donc multiplié la valeur de son investissement par 3,3, juste par le mécanisme de l’effet de levier.
This structure is particularly suitable for the acquisition of a company by its managers, an operation known as an LMBO (Leveraged Management Buyout), or by an external manager in an MBI (Management Buy-In), provided, of course, that the company is sufficiently profitable.
It's worth noting that one of the advantages of a LBO setup is that it compels the implementation of management tools, reporting, and cash flow monitoring within the company (if not already in place). This is done to ensure the adherence to the business plan and debt repayment schedule.
The creation of the acquisition holding allows for the implementation of three other types of leverage effects:
With a holding company and minority shareholders, an acquirer can control a target company with an investment that wouldn't allow them to have a majority stake if they were to directly acquire the target. This mechanism can be achieved "in cascade."
Thus, in the event that the acquiring manager does not have sufficient capital to have a majority stake in the acquisition holding company (Holding 1), instead of directly investing in it, they can invest through their own holding company ("Holding 2") by bringing in minority investors as shareholders in Holding 2.
For example, in the scenario mentioned above, the buyer has only €1 million (instead of the required €3 million) to acquire the target company valued at €10 million. They find investors willing to invest €1.5 million in the capital of the acquisition holding company (Holding 1). If the acquirer were to invest directly in Holding 1, they would have a minority stake with only 33% of the capital.
Therefore, he creates Holding 2 with his €1 million contribution and bring in minority investors (possibly through love money) with €0.6 million in capital for Holding 2. This give him a 62.5% ownership stake in Holding 2, where he serves as the chairman and have control. Holding 2 invests its €1.6 million capital in Holding 1 for the acquisition, and €1.4 million is contributed by investors in Holding 1. Holding 2, represented by the acquirer, holds a majority stake of 53.3% in Holding 1 and controls it. Finally, Holding 1, with the required €3 million in capital, acquires the target company as outlined in the previous structure.
This "cascading" structure allows the acquirer to control the target company, even though they indirectly own only 33.3% (62.5% x 53.3%) and have invested only €1 million out of the required €3 million in capital.
In a tax consolidation scheme, the tax deficit of the holding company (related to financial expenses) reduces the corporate income tax of the tax group (holding + target).
The participation of key executives in the capital and, if applicable, their incentive to share in the financial partner's profit, are motivating factors that bring dynamism to companies acquired through LBOs.
In this case, « management packages » (« MANPACK »). These mechanisms are put in place and are particularly attractive for managers, often allowing them to significantly multiply their investment.
The possibility of acquiring a company through a LBO depends on several factors, including :
Furthermore, it's worth noting that the current tightening of lending conditions by banks and the rise in interest rates observed since 2022 are significantly limiting the portion of debt that can be used for acquisition financing, even if the profitability of companies is not necessarily affected. These factors are leading to the abandonment of certain acquisition projects or pushing down company valuations.
The structuring of a LBO process can be complex and needs to be tailored to the target, the acquirer's project, their financial strategy, and market conditions.
It first requires having a detailed financial analysis, both historical and future, of the target company, as well as a robust business plan. MBA Capital analyzes these elements and puts them to the test : assessing the coherence of the figures, credibility for the financial community, feasibility of the opération, target valuation and valdiation.
MBA Capital will then design the optimal structure that allows for the optimization of all financial parameters while aligning with the buyer's objectives, especially in terms of the degree of control within the structure. The goal is indeed to maximize the use of the least expensive financing sources (senior bank debt) and calibrate the use of other financing tools such as mezzanine debt, bonds, convertible bonds, bonds with warrants, preferred stock, etc. to minimize, in principle, the capital contribution required from external investors (the most expensive financing source). All of this is done in consideration of the transaction's characteristics, legal and financial constraints, and market data.
Next, it will be necessary to prepare a detailed presentation of the transaction and the structure, targeting various potential funders. Those funders should be selected based on their suitability for the project and the buyer's preferences.
An important step where MBA Capital's intervention is particularly valuable is in the negotiation with those funders, both banks and investors, to optimize the terms of the contracts (loan covenants, shareholder agreements, warrant contracts, etc.).
MBA Capital supports buyers, whether they are groups or managers, in all of these potentially complex steps, solely in the interest of the LBO project stakeholders, and with complete independence from funders, whether they are banks or others.
MBA Capital Bordeaux
Posted on July 21, 2023.
To receive the latest information from MBA Capital, subscribe to the newsletter!
FR 
