What is a Leveraged Buy Out and How Can It Help You Make a Better Small Business Deal?
What is an LBO?
An LBO is simply YOU. You using Leverage to buy a small to medium business, probably a larger business than you would otherwise be able to purchase without financing.
Isn’t This Just For Wall Street and Mega Deals?
That is probably what most people think, but leverage is a tool that a Buyer Consultant should be informing you about, especially if you are not an ‘all-cash buyer’. You will want to understand and apply the principle of ‘OPM’ to the greatest extent possible. The fact is that leverage is used to acquire businesses of all sizes. LBO is not just for large corporations and Wall Street Money Moguls.
What is an OPM?
O.M.P. stands Other People’s Money. Often tossed around as a joke, OPM is to Capitalism and Finance as ‘Love and Marriage and a Horse and Carriage’. There once was a time that Americans saved all their lives to buy a house. Cash. And not many owned houses unless you were a homesteader! Then along came Lenders. Savings & Loans. Credit Unions and Banks. And now you buy a house with little or no down payment and a big mortgage. That is Leverage. That is using OPM.
How This Applies to Buying a Business is Similar
Using OPM is key. In any business acquisition transaction, you want to utilize leveraged buyout (LBO). In LBO, you acquires the business using a minimal amount of your own capital and then leverage, (financing) i.e. using the business own assets as collateral. Of course, this only works only if the business has strong FF&E assets as collateral and the business can produce enough cash flow to cover the daily business’ expenses and now this new debt service.
What Are the Pros and Cons of a Leveraged Buyout?
LBOs have the advantage that they allow you to buy an asset-heavy company for little money down. FF& E (Furniture, Fixtures and Equipment), Vehicles, Accounts Receivable (A/R), Cash in Bank, Patents, etc all can count as assets. This leverage is a benefit that allows you to acquire a larger business than you would otherwise be able to purchase – without financing.
While the above may already be obvious, as a Consultant to you, the Business Buyer, I would point out that the use of leverage greatly increases your return on funds invested. The downside is equally obvious, and I would be the first to caution you and point out that leverage is a double-edged sword. It all comes down to ‘risk-tolerance’, burning desire, and most importantly, doing the math. I can help with the second part! If you miscalculate or ‘stranger things’ occur that are an outlier – you can be flipped upside down. Bad turns of events can potentially eliminate all your hoped-for returns. Your equity can plummet if things don’t go as planned. As such, I caution, (1.) do a gut check of your risk tolerance, (2). Do the math and calculate costly possibilities and how you will deal with them, and (3) use an LBO with caution. Now, if I have been diligent in pointing out that leverage is a double-edged sword, let me simply conclude by saying, “Buying a business involves risk. So does walking out your front door (Quoth: Bilbo Baggins). There is no gain without risk. If you have the temperament to take the leap, Do It! Go for the American Dream! Use OPM and join millions who have taken the leap to business ownership. And be prudent in risk assessment, including, engaging wise advisers. That is not the area to go cheap on. Leverage your wisdom with that of a Pro.