LBO - leveraged buyout opportunity - things to consider

April 02, 2019

by a searcher from Dartmouth College in Allentown, PA, USA

I am in talks with a company that does $3.6MM in EBITDA on $8.5MM of revenue. They have been operating for 40+ years and appear to have consistent cashflow with a high degree of recurring revenue. The company also has excellent creditworthiness with its bank. I'm considering a leveraged buyout strategy for this acquisition given the creditworthiness.

Are there any "watch outs" I should consider in pursuing this path as a self-funded searcher? Am I naïve to think a bank would load this sort of company up with debt to be managed by someone with limited operating experience?

I have a warm group of investors that are experienced and would be interested to participate in an equity capacity. However, I'm wondering if a LBO path should be given more consideration.

I appreciate any insight and guidance the community can share based on prior experiences. Thank you

Reply by a searcher
from University of Pennsylvania in Miami, FL, USA

just for clarity sake, an LBO does not preclude the use of equity....in fact, there is almost always equity in an LBO, just a smaller amount than what some would consider sane :). I say go for it, as long as your diligence reveals a stable company that 1) you can operate; 2) can convince the banks you can operate; and 3) you can get the banks/owners to agree to the leverage you want to use. I have a hard time believing a commercial lender would not require a decent amount of equity, however they may view seller note as equity. Kudos to you for finding such a deal and would be great to see it happen for you!!!! BTW, in the case of having to raise equity, you can also structure a deal with your investors where you have the right to buy them out at some pre-determined IRR or MOIC. That way, you wont need as much leverage, and if the business cash flows as you mentioned, you'll be able to quickly pay down debt and buy out your investors. Depending on the multiple and bank terms, it may put you in a safer position in case the company did not perform as you thought it would.

Reply by a professional
from Harvard University in Boston, MA, USA

Think very carefully about whether the margins will hold up with sub $10m deals with high margins, especially before you load it with debt. I've seen sub $10m businesses where the founder/CEO can allocate responsibilities in a way that is very difficult to duplicate by an outside party. The new owner lacks the customer/vendor relationships, decades of domain expertise and longstanding working relationship with relatively unskilled employees - who might really rely on the prior owner's guidance in small but important ways. Said another way, be honest with yourself as you try to answer the question of whether the owner "is" the business and whether the current cost structure will hold under your ownership.

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