Handbook of Alternative Assets Ch 17 - Leveraged Buyouts Flashcards
Describe leveraged buyouts (LBOs)
Leveraged buyouts (LBOs) involve public companies repurchasing all of their
outstanding shares and turning themselves into private companies
State the benefits of a buyout from the perspective of corporate management
The benefits of a buyout from the perspective of corporate management are:
Use of leverage whose interest payments are tax deductible
Less scrutiny from public equity investors
Freedom from a distracted corporate parent
Ability of management to become significant equity holders with upside in the
business
State the three tranches of LBO financing
Three tranches of LBO financing:
1. Senior Debt
2. Mezzanine debt
3. Equity
State the five general categories of LBOs that illuminate how LBO transactions can
create value
- LBOs that Improve Operating Efficiency
- Unlocking an Entrepreneurial Mindset
- The Overstuffed Corporation
- Buy and Build Strategies
- LBO Turnaround Strategies
State the different types of fees used by LBO firms
Annual management fee of 1.25 - 3%
Incentive fees to share profits of 20 - 30%
Fee for arranging and negotiating the LBO transaction
Breakup fees
Other fees (divestiture fees, director’s fees, etc.)
State the financial characteristics LBO firms look for in leveraged buyout candidates
LBO firms look for the following financial characteristics:
History of profitability with steady profit margins
Strong free cash flows to service additional debt levels
Balance sheet this is not already overburdened with a high debt level
Strong balance sheet with a large cash/current asset balance
Weak stock price
State the operating characteristics LBO firms look for in leveraged buyout candidates
LBO firms look for the following operating characteristics:
Mature firm with a strong brand name and competitive market position
Products that are not subject to technological obsolescence
Diversified customer base that generates recurring revenues
Management team that might need some improvement to increase operating
efficiency
Compare venture capital and leveraged buyouts
Company Characteristics Startup Mature
Market environment Developing Developed
Product demand Undiscovered Established
Customer base Early adopter Widespread acceptance
Management type Entrepreneur Seasoned
Management skills Idea generation Operations management
Revenues Just beginning Recurring & predictable
Capital consumption Ravenous Conservative
Competitive advantage New technology Distribution, marketing, production
Financing characteristics Venture capital Leveraged buyout
Target IRR 40% to 50% 20% to 30%
Shareholder position Minority Control of company
Board seats One or two All
Valuation Compare to other companies Discounted cash flow model
Use of debt Non existent Majority of financing
Investment strategy Finance innovation Improve operating efficiency
Time to exit 2 to 5 years 4 to 7 years
Exit options IPO, acquisition IPO, acquisition or recapitalization
Describe risks of LBOs, stating the main risk of LBOs and also describing the reasons
why LBOs have less risk than VC deals
Main risk of an LBO is the extreme leverage used
High debt-to-equity ratio
Little margin for error; need to generate enough cash flow to service bondholder
payments or may end up in bankruptcy
Reasons LBOs have less risk than VC deals:
1. Target company is more mature/seasoned – LBOs target mature companies with
undervalued assets, VC deals target startup companies
2. Established management team, easier assessment of key employees
3. LBO target usually has established products or services and a history of earning
profits
4. Exit strategy of a new IPO in several years is much more feasible with an LBO since
the company already had public equity
Define corporate governance
Corporate governance - the process by which the managers of a corporation align
their interests with the equity owners of the business (i.e. the shareholders)
Define merchant banking
Merchant banking - the practice of buying nonfinancial companies by financial
institutions
