1. Leveraged Buy Outs
By AV Vedpuriswar

2. Going Private
Transformation of a public corporation into a privately held firm

3. LBO Basics
An acquisition largely financed by borrowing of all the stock or assets of a hitherto public company by a small group of investors.
Typically the buying group forms a shell corporation to act as the legal entity making the acquisition.
In a stock purchase format, the target shareholders simply sell their stock to the buying group.

4. In an asset purchase format, the target corporation sells its assets to the buying group.
The original shareholders still own the target corporation, now merely a pool of cash with no tangible assets.
The target corporation issues a liquidating dividend to its shareholders or becomes an investment company using the pool of cash to make investments whose proceeds are distributed to shareholders.

5. LBO Financing
In an LBO, debt financing typically represents 50% or more of the purchase price.
The debt is secured by the assets of the acquired firm and is usually amortised over a period of less than 10 years.
The debt is scheduled to be paid off as funds are generated by operations or from the sale of assets of the acquired firm.
The sale of assets may happen if the group which has taken charge, feels unwise acquisitions have been made in the past.

6. LBO Financing ( Contd)
There may be limited equity participation from outside investors such as pension funds and insurance companies.
Often this comes with the provision that the equity interest will be repurchased after a predetermined period to provide a specified yield.
The firm is run as a privately held entity for several years and then sold off at a profit.
In an MBO, the purchasing group is led by an executive of the parent company.

7. Stages in LBO
The first stage consists of raising the cash required for the buyout and devising a management incentive system.
Typically about 10% of the cash is put up by the investor group headed by the company’s top manger‘s and/or buyout specialists. This becomes the equity base of the new firm.
Outside investors provide the remainder of the equity.
Managers receive stock price based incentive compensation in the form of stock options/warrants.
The equity share of the management (not including directors) may go up to more than 30%.

8. Stages in LBO (Contd)
About 50 – 60% of the required cash is raised by borrowing against the company’s assets in secured bank acquisition loans.
The rest of the cash is obtained by issuing senior and junior subordinated debt in a private placements (pension funds, insurance companies venture capital firms, etc) or public offering as high yielding junk bonds.
Subordinated debt is also called mezzanine money with provision for payment-in- kind in the event of adverse conditions and inadequate cash flows.

9. Stages in LBO (Contd)
In the second stage of the operation, the organizing sponsor group buys all the outstanding shares of the company and takes it private or purchases all of the assets.
In the third stage, the management strives to increase cash flows and profits by cutting operating costs and streamlining marketing efforts.
Various cost cutting efforts are initiated.
In the fourth stage, the investor group may take the company public again if a leaner and meaner company emerges and the goals of the group have been met.
The reverse LBO may be affected through a secondary initial public offering.