{"id":8660,"date":"2022-11-01T16:56:21","date_gmt":"2022-11-01T15:56:21","guid":{"rendered":"https:\/\/www.simtrade.fr\/blog_simtrade\/?p=8660"},"modified":"2022-11-01T16:56:21","modified_gmt":"2022-11-01T15:56:21","slug":"what-are-lbos-and-how-do-they-work","status":"publish","type":"post","link":"https:\/\/www.simtrade.fr\/blog_simtrade\/what-are-lbos-and-how-do-they-work\/","title":{"rendered":"What are LBOs and how do they work?"},"content":{"rendered":"

What are LBOs and how do they work?<\/h1>\n

\"Louis<\/a><\/p>\n

In this article, Louis DETALLE<\/a> (ESSEC Business School, Grande Ecole<\/i> Program – Master in Management, 2020-2023) explains why LBOs are so trendy and what they consist in.<\/p>\n

What does a LBO consist in & how is it built?<\/h2>\n

LBO stands for a Leverage Buy-Out. It means a company acquisition which is funded with a lot of debt. Often, when an LBO is performed, 70% of the funds used for the acquisition come from debt, the 30% left being equity.<\/p>\n

Figure 1. Schematic plan of the organization of an LBO.<\/p>\n

\"Sans<\/a>
\nSource: the author.<\/p>\n

To perform an LBO, the company wishing to buy the company called Target in this example will have to create a Holding company specially for this purpose. The holding will then take on some debt with specific lenders (banks, debt funds) under the form of loan or bonds. After that, the holding will have both some initial equity from the company wishing to acquire Target and some debt to buy Target.<\/p>\n

What happens after the target has been bought?<\/h2>\n

Well, after the target has been bought, since the target company has an operating activity which motivated the acquiring company to buy it, this means that the target company had great financial performance. And it better to be the case! Otherwise, the large amount of debt taken for the operation will never be reimbursed to the lenders.<\/p>\n

The principle is that target\u2019s financial cash flows will be redistributed to the holding in the form of dividends, and the holding will use these dividends to pay back the debt to the lenders until all debt is reimbursed.<\/p>\n

What makes a company a good LBO target?<\/h2>\n

A good LBO target should respect a few conditions related to the target company: important operating cashflows, a mature market, A company whose development cycle is over.<\/p>\n

Important operating cashflows<\/h3>\n

First & foremost, without great cashflows, the holding will never be able to reimburse the debt taken with the dividend if they are insufficient. For that matter, the company targeted for the LBO should have both regular & important cashflows.<\/p>\n

A mature market<\/h3>\n

When looking at the bigger picture, the company willing to acquire a target with a LBO must make sure that the market in which the potential target evolves is stabilized. Because LBO means major financial risk due to the amount of debt involved, a company cannot also add operational risk.<\/p>\n

A company whose development cycle is over<\/h3>\n

Once again, the target company will ensure the reimbursement of a high debt. This is why all capital expenditures (CAPEX) and major investments such as machines, fleets of vehicles should have been already done.<\/p>\n

Useful resources<\/h2>\n

Vernimmen\u2019s book chapters on LBOs<\/a><\/p>\n

Youtube video on a LBO Case Study <\/a><\/p>\n

Related posts on the SimTrade blog<\/h2>\n

   ▶ Fr\u00e9d\u00e9ric ADAM Senior banker (coverage)<\/a><\/p>\n

   ▶ Marie POFF Book review: Barbarians at the gate<\/a><\/p>\n

   ▶ Akshit GUPTA Analysis of Barbarians at the Gate<\/i> movie<\/a><\/p>\n

About the author<\/h2>\n

The article was written in October 2022 by Louis DETALLE<\/a> (ESSEC Business School, Grande Ecole<\/i> Program – Master in Management, 2020-2023).<\/p>\n","protected":false},"excerpt":{"rendered":"

What are LBOs and how do they work? In this article, Louis DETALLE (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2023) explains why LBOs are so trendy and what they consist in. What does a LBO consist in & how is it built? LBO stands for a Leverage Buy-Out. It means a … Read more<\/a><\/p>\n","protected":false},"author":58,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[5,10],"tags":[348],"class_list":["post-8660","post","type-post","status-publish","format-standard","hentry","category-contributors","category-financial-techniques","tag-lbo"],"yoast_head":"\nWhat are LBOs and how do they work? - SimTrade blog<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.simtrade.fr\/blog_simtrade\/what-are-lbos-and-how-do-they-work\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"What are LBOs and how do they work?\" \/>\n<meta property=\"og:description\" content=\"What are LBOs and how do they work? In this article, Louis DETALLE (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2023) explains why LBOs are so trendy and what they consist in. What does a LBO consist in & how is it built? LBO stands for a Leverage Buy-Out. It means a ... 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