What is an LBO?

Definition of an LBO

If you're wondering what LBO stands for, here's a definition to enlighten you. LBO is an acronym for leveraged buy-out, also known as leverage buyout. In concrete terms, this involves the acquisition of a company by means of a bank loan supplemented by the subscription of bonds.

Once the bonds have been redeemed, the company concerned is generally floated on the stock market, or resold, in order to enable all investors to "exit" the company and realize a capital gain. The holding company carrying out the LBO will not have committed any personal funds, but will have managed to pay the bank financing for the buyout out of dividends alone.

The different types of LBO

If you were wondering, yes, there are different types of LBOs, which Cabinet Sion Avocat explains below:

• LMBO (Leveraged Management Buy-Out) when the buyers are senior executives of the acquired company.
• If the investors (buyers) come solely from outside the company, we speak of LBI (Leveraged Buy-In).
• If the acquirers are company executives AND outside investors, the transaction is known as a BIMBO (Buy-In Management Buy-Out).
• If the purpose of the takeover is to merge the company with another, the term LBU, or Leveraged Build-Up, is used.
• If the investors are from outside the company and change the management team at the same time as the buyout, the term LMBI (Leveraged Management Buy-In) is used.
• Finally, if the company's current owner participates in the transaction and is one of the buyers, we use the term OBO, Owner Buy-Out.

In either case, the buyers become majority shareholders in the company they are buying.

Why do an LBO?

Leveraged buyout is a process enabling a company to buy another company, using as little of its own capital as possible. It is, for example, an ideal model for employees wishing to buy out their boss's company.

With regard to the LBO scheme, the acquiring company sets up a holding company, in which it has a majority stake. It will be accompanied by banks or investment funds which will also be partners in the holding company. The holding company will acquire the shares of the purchased company...

But what are the advantages and disadvantages of an LBO? Cabinet Sion Avocat can help...

The advantages of LBOs

An LBO is a leveraged buyout. This means that the capital employed to finance the Leverage buy-out will have a profitability superior to the cost of borrowing.

In addition, one of the advantages of LBOs is tax optimization. The investors will be able to profit from a tax leverage effect since the holding will be able to deduct the interest loan its tax. By opting for the tax consolidation mechanism, the target company's profit will be reduced by the holding company's loss, resulting in a lower taxable share.

Finally, when exiting the LBO, the shareholders can merge the holding company and its subsidiary before a possible IPO or resale, which could generate a handsome capital gain for the initial buyers.

The disadvantages of LBOs

This type of buyout is only worthwhile if the target company is profitable. If this is not the case, the company will not be able to pay dividends to the holding company, and therefore will not be able to repay the loan taken out for the buyout.

One of the major risks of an LBO is therefore a poor analysis of the target company's ability to repay the loan, which is why it is important to consult a tax lawyer before embarking on the buyout. This specialist can help you assess the growth potential of the target company, to ensure that an LBO is the most appropriate way to acquire it.

How to make an LBO?

As you can see, the starting point for an LBO is the creation of a holding company to acquire the target company. You can read more about this in Cabinet Sion Avocat's article on setting up a holding company.

This holding company will generally contribute around 25% of the value of the acquired company, and borrow the balance.

In a second phase, the cash flow of the acquired company is transferred to the holding company, through the payment of dividends, which may be regular or exceptional. In other words, it is the acquired company that finances the LBO operation, provided it is sufficiently profitable! This means that the feasibility of a leveraged buyout depends on the target's ability to repay the loan used to finance the acquisition...

There are three levels of debt, each corresponding to an increasing level of risk:

• Traditional 7-year debt, known as "senior" because it is repaid first. This is the least risky part of the financing package.
• "Bullet" debt, which is repaid at maturity, once repayment of the conventional debt has been completed. It is therefore logically a little riskier than the previous one.
• Finally, "mezzanine" debt is the riskiest part of the package, since it is only repaid at the end, and is subordinated to repayment of the senior debt. The capital injected here will be the best remunerated, given the risk taken.

 

So, if you're looking for more information, or if you're considering acquiring a company as part of an LBO, don't hesitate to contact Cabinet Sion Avocat, tax lawyers in Marseille (and online!) specializing in company buyouts and tax optimization, who can help and support you!

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