The Founder’s Guide to Leveraged Buyout Financing in 2024

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Arc Team


Given you’re reading this guide, we’re going to assume you’re considering acquiring another startup or small business. If that’s the case great, you’ve come to the right place! In this guide, we break down what leverage buyouts are, how they work, and their key characteristics. We also answer the frequently asked questions. We also share real-life examples of successful leveraged buyouts. Ready? Let’s dive in!

What leveraged buyout financing is (and isn’t)

A leveraged buyout (LBO) is a financial transaction in which a startup or a group of investors uses a significant amount of borrowed financing, or leverage, to acquire another business. The acquiring entity, often a private equity firm or startup, utilizes a combination of equity and debt to fund the purchase of the target company. The assets of the target company, as well as the cash flow generated by its operations, serve as collateral for the borrowed funds.

Leveraged buyouts are common in situations where the acquiring party believes it can improve the target company's performance, generate operational synergies, and ultimately achieve a profitable exit, such as through a sale or public offering. The goal is to increase the potential return on investment by magnifying the equity portion with borrowed money.

How leveraged buyout financing works

The process for a leveraged buyout typically involves the steps outlined below.

  • Identification and Evaluation of the Target Company: The acquiring entity identifies a target company that aligns with its investment strategy and growth objectives. Due diligence is conducted to assess the target's financial health, market position, and growth potential.
  • Financing Structure and Negotiations: The acquiring entity structures the financing for the deal, determining the mix of equity and debt. The terms of the financing, including interest rates, repayment terms, and covenants, are crucial aspects of the deal.
  • Acquisition and Post-Acquisition Strategy: Once the financing is secured, the acquisition is executed. Post-acquisition, the acquiring entity often works on implementing strategic changes, operational improvements, or cost-saving measures to enhance the value of the target company.
  • Spin-Off: The final (optional) step of the LBO process, once the target company has been acquired and “turned around” is its sale or public offering.

The key characteristics of leveraged buyout financing

  • Leverage: The use of borrowed funds is a defining feature. This leverage magnifies the equity investment, potentially increasing returns but also adding financial risk.
  • Private Ownership: LBOs often result in the target company becoming privately held. This allows the acquiring entity to make strategic changes and operational improvements away from the scrutiny of public markets.
  • Operational Improvements: Acquirers typically aim to enhance the performance of the target company by implementing operational efficiencies, cost-saving measures, and strategic initiatives.
  • Exit Strategies: Investors in LBOs seek profitable exits through avenues such as a subsequent sale, public offering, or recapitalization after adding value to the acquired company.

The historical context and success stories of leveraged buyout financing

Leveraged buyouts became popular in the 1960s and 1970s with the rise of corporate raiders and hostile takeovers from PE firms. Generally speaking, those tactics were looked down upon by the general public and most business operators, and the demand quickly subsided. Since then several companies have had success with leveraged buyout transactions—we’ve outlined them below.

  • RJR Nabisco (1988): One of the most famous LBOs, depicted in the book and film "Barbarians at the Gate," involved the acquisition of RJR Nabisco by Kohlberg Kravis Roberts & Co. (KKR). It was later sold to Mondelēz International.
  • Dell Inc. (2013): Michael Dell, in partnership with Silver Lake Partners, executed a successful LBO to take Dell private, allowing the company to undertake strategic initiatives away from the pressures of the public market. Dell re-entered the public markets in 2018.
  • Twitter (2022): Elon Musk purchased Twitter on October 27, 2022, for $44B after months of negotiation with the plan to restructure the company. While it has not gone public again, or been spun off, it has been renamed to “X”.

How LBOs differ from traditional acquisitions

There are a few elements that differentiate LBOs from traditional acquisitions, we’ve outlined them below.

  • Capital Structure: LBOs rely on a significant amount of debt, often exceeding the equity contribution, while traditional acquisitions are typically financed with a higher proportion of equity.
  • Level of Control: LBOs often result in a high level of control for the acquiring party, allowing for strategic and operational decisions, whereas in a traditional acquisition, control may be shared, and decisions can be subject to the approval of a larger group of shareholders.
  • Exit Strategy: LBOs often come with a predefined exit strategy and timeline, whereas traditional acquisitions typically result in the integration of the acquired company’s operations into the acquiring company's operations.

The common leveraged buyout financing options

  • Debt Financing: Debt financing is a cornerstone of leveraged buyouts, involving the use of borrowed capital to fund the acquisition. Common debt instruments include bank loans, venture debt, and unitranche debt. These senior debt instruments offer varying terms, interest rates, and repayment structures, providing flexibility for the acquiring entity.
  • Equity Financing: This is the traditional venture capital funding we all know and love. Investors provide capital to the company in exchange for an ownership stake in the entity. For more information, check out the ultimate guide to equity financing and the founder’s guide to structured equity financing.
  • Mezzanine Financing:  Mezzanine financing involves subordinated debt, often with equity warrants. Mezzanine financing can bridge the gap between traditional debt and equity, offering an additional layer of capital for leveraged buyouts. For more information, check out the ultimate guide to mezzanine financing.

The key advantages of leveraged buyout financing

Leveraged buyout (LBO) financing comes with several advantages for startup founders exploring strategic growth through acquisition. One key benefit is the ability to retain ownership and control over the acquired company. Another key advantage is the ability of founders to access substantially more capital than they otherwise would be able to enabling them to complete larger acquisitions. The final key benefit is the speed at which the funding flows. With most acquisitions, it can take months or even years to complete, with LBOs the end-to-end process can be as little as a few weeks—when speed is of the essence, LBOs are a startup’s best friend.

The key disadvantages of leveraged buyout financing

While leveraged buyouts can be very beneficial for startups, there are some key disadvantages associated with this form of financing. First, it can lead to massive overleveraging. Because startups often receive access to more funding than is typically available to them, their eyes may become “bigger than their stomachs”—meaning they acquire a company that is too big and they can burden themselves with too much debt. If things do not go as planned and they are unable to “turn around” the company, they can bring down not only the company they acquired but also the company they founded. The other major disadvantage is the cost of the capital. Typically LBOs contain both a debt and equity component which can the financing very expensive.

Frequently asked questions (FAQs) about leveraged buyout financing

What distinguishes leveraged buyouts from traditional acquisitions?

Leveraged Buyouts differ from traditional acquisitions in their funding structure. LBOs heavily rely on borrowed funds, allowing the acquiring entity to maximize returns with a smaller equity investment. This contrasts with traditional acquisitions, where a higher proportion of the purchase price is often financed using the acquiring company's funds.

Can leveraged buyouts be used by both small and large startups?

Yes, leveraged buyouts can be utilized by startups of varying sizes. While the scale of the LBO may differ, the fundamental principle remains the same – using a combination of debt and equity to acquire a target company.

How does the economic climate impact the feasibility of Leveraged Buyouts?

The economic climate can significantly impact the feasibility of leveraged buyouts. During periods of low-interest rates, borrowing costs may be more favorable, making LBOs more attractive. Economic downturns, on the other hand, may increase the financial risks associated with leveraged financing, influencing decision-making.

What industries are best suited for Leveraged Buyouts?

Leveraged Buyouts can be applied across various industries. However, industries with stable cash flows, growth potential, and opportunities for operational improvements are often more conducive to successful LBOs. High-tech, healthcare, and manufacturing are examples of sectors where LBO strategies have been employed effectively.

Wrap up - pursuing leveraged buyout financing in 2024

Growth through acquisition is one of the most efficient paths for startups. Through leveraged buyout financing, startups can complete the funding for an acquisition within a few weeks. They can also typically make a much larger acquisition than they otherwise would be able to, and retain control over the acquired company’s operations. However, LBOs can be a double-edged sword because startups can access more capital than is typically available, and they can quickly become overburdened with debt.

If you are looking for leveraged buyout financing, we’d love to help—get in touch with us.

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