Leverage Buyout

Leverage
Buy out
Concept
When a company acquires another company using a significant amount of
borrowed funds such as bonds or loans to pay the cost of acquisition, the
transaction is termed as leverage buyout.
It is worth noting that assets of the target are offered as collateral security for the
purpose of raising loans in addition to the assets of the acquirer.

A leveraged buyout occurs when a financial sponsor gains control over the target
company’s equity through the use of borrowed funds.

LBO are popular for they allow companies to make large acquisitions without having to
commit a lot of capital.

An LBO most often involves a ratio of 70% debt and 30% equity, although the ratio of
debt can reach as high as 90% to 95% of the target company’s total capitalization.

Because of this high debt/equity ratio, LBOs pose a very high risk of bankruptcy.
LBO Finance option
Revolving credit facility
• Bought out firm relies on to secure its working capital requirement; also helps
to secure against unforeseen cost.

Bank debt
• It represents finance secured by mortgaging the assets of the bought out firm.

Mezzanine debt
• Middle of capital structure w.r.t priority in repayment. Here repayment priority
is lower which is compensated by higher interest rate.

Subordinated or higher yeildnotes:

• These notes carry a very high rate of interest and low security. Each tranche of
debt financing has different maturities and repayment.
 Benefits of LBO
Heavy interest and principal repayments force managements to improve
performance and operating efficiency.

Debt may encourage companies to focus on initiatives such as divesting non-

core business, downsizing, cost cutting, and investing in technological
upgrades. These are very often postponed or rejected outright.

LBOs are able to generate healthy returns for they focus on reducing
unnecessary overheads and selling unrelated business units, thus cutting the
company down to a productive core.
Types of LBO

SPONSORED LBOS:-
• NON-SPONSORED LBOS:
Management MBO is a process where managers and/or
executives of a company purchase the
Buyouts controlling interest in a company from
existing shareholders.

The management usually buys the target

from the parent company. Of course, it is
very important to establish whether the
parent company is willing to sell the
company.
To facilitate a MBO a new company is
incorporated to buy the business or shares
of the target company.
g.no. 945 of Prasanna
handra
Concept
The Need of ESOPs

Micro Principle
• Productivity
Macro Principle • Savings
• Investment tool
• HRM
• Defense against hostile
takeover
 Types of ESOPs

NON- LEVERAGED LEVERAGE-ISSUANCE LEVERAGE BUYOUT

ESOPS ESOPS ESOPS
Non –Leveraged ESOPs

Company makes annual

Company Sets up an tax-deductible Cash is used to buy-
ESOP trust contribution in cash or back from SH
stock

4) Employee receives
ESOP holds stock,
Shares are allotted to stock or cash at the
annually announces the
the eligible employee time of retirement or
no. and price of the
within ESOP when they leave the
stock
company.
Leveraged Issuance ESOPs
1) Loan
Qualified Lender
Company
2) Loan
6) 8) Loan Repayment
to ESOP 3) Loan 4) 7) Minor
Procee Shares Annual Loan
ds of New Contrib Repaymen
Stock ution t

ESOP TRUST
Suspense Account

Allocation
5
Participants
Leveraged Buyout ESOPs
1) Loan
Qualified Lender
Company
2) Loan
8) Loan Repayment
to 6)
7)Loan
ESOP Annual
Repaymen
Contribu
t
tion

ESOP TRUST
Suspense Account 4) Cash
Allocation Selling SH
3
Participants 5) 6) Reinvestment
Stock
Stock &
Bonds
Advantages
Capital Appreciation
Incentive Based Retirement
Tax Advantage
Company Reduces Tax Liabilities
It can recover tax paid in prior year
It infuses working capital and cash flow
It helps in corporates tax deduction
Reduces cost of employee
Reduces attrition rate
Disadvantages
Fiduciary Stock
Dilution Liquidity
Liability Performance

Expensive To Need Annual Excessive

Complex
Implement Upkeep Leverage

Complicated
Accounting