Funded buyback

Leveraged Buy-Out ( LBO ) - a type of activity of companies from the private investment sector, in which the company is redeemed at the expense of borrowed funds.

Content

The Economic Entity of LBO

With a funded buyback, the entity changes the structure of the sources of funds, replacing the relatively expensive net worth with borrowed funds. Over the course of several years, repayment of borrowed funds and increase in equity are carried out. After 4-6 years, the company is sold to a new owner. At the same time, the saving on the cost of capital remains with the company conducting the LBO.

Example: a company financed from equity at 100%, with a weighted average cost of capital of 15%, is redeemed to finance 30% of equity at 70% of borrowed capital, with a weighted average cost of 8%. Suppose a company fully pays a debt out of profit for 5 years and then sells it. Capital costs before LBO are 15%, capital costs after LBO are 65% * 15% + 35% * 8% = 12.55%, where 65% is the average share of equity, 35% is the average share of borrowed funds. Savings of 15% -12.55% = 2.45% are capitalized on the buyer's accounts.

LBO Members

A funded buyback is made with the participation of four parties - the object / target, creditors, the buyback organizer and the legal entity accumulating the target’s assets.

Object / purpose of LBO - a company that gives its assets to a new legal entity in exchange for cash. Lenders are suppliers of borrowed capital, both secured and unsecured. Buyback organizer - participates in a new legal entity with its own capital, depositing funds. Legal entity - accumulates funds from creditors and the organizer, exchanges for the assets of the object

LBO Objects

The most likely LBO targets are companies whose credit risk is currently low. Undervaluation is a criterion for increasing attractiveness. In this case:

Stable cash flow (or profit before interest, taxes and depreciation)
Low financial leverage at the moment
Predictable Capital Costs

are positive factors in making a decision on a funded buyback

LBO Funding

Funds for a funded buyback can come from 4 sources of various risks:

Secured bank loan (pledge, guarantee and other methods). Such financing has the lowest percentage and highest priority for satisfying its requirements.
Unsecured bank loan or subordinated loan . The rate is higher than for the first category, the order of payments is second.
Preferred shares or other forms of debt, with a higher rate of return than for the second category and third priority of payments.
Equity of participants, which carries the risk of losses and accumulates all the profitability of the transaction upon completion.