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LBO Financing | Definition | Top 6 Strategies for LBO Financing - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell icon today we have a
topic with us is lbo financing we'll try
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and understand what is leverage buyout
financing and how exactly this is done
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you have a dialogue box we are saying
that you know being capital have secured
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$3.17 billion of debt
commitments from banks to finance their
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acquisition of German drug maker starter
in what is said to be Europe's largest
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sub investment grade LBO financing so
far this year okay no issues this has
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gone little what we call as more
complicated language but we'll try
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and make its will simplify now what is
LBO financing seen an LBO transactions
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a private equity firm they acquire a
company or a part of company by
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investing a small amount of equity and
majority using the leverage to finance
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an LBO a private equity firm primarily
uses you know what we call as borrowed
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fund borrowed money to meet the cost of
the acquisition this kind of P form the
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uses debt to lift its returns using you
know more leverage means the P firm will
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earn a higher returns on its investments
it's called return on equity as a sort
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of sign LBO financing is tough job even
if on the surface it looks easy private
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equity firm funds needs to go an extra
mile to finance LBO transaction so in
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this tutorial have a look at various
options the private equity firms have
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for such LBO financing the top 6
strategies well your financing you know
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when a private equity invest in lbo
it needs to put in a lot of borring money
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let's have a look you know at how
private equity firms the finance the LBO
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okay the first and the foremost way they
do is seller financing now what is this
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see the LBO financing strategy is often
seen when the seller is pretty much
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interested in making the sale so that's
why the seller can be convicted to
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extend a loan which can be amortized
over the years so seller financing is
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also very helpful for the buyer gets the
comfort of paying of the debts when the
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enough money of the flow
into the business second is called the
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equipment financing see this is another
form of LBO financing which has been
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used by the buyer now if the company
owned any equipment which are free there
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is no way this equipment will be used in
future so the part of the purchase price
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can be the equipment moreover if the
equipment has equity that has that can
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be financed to I mean that's gonna be
part of a tourist by the own funds and
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this kind of help you financing the
private equity invest closely 30 to 40%
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50% closely of money in
equity meaning its own money and the
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rest of the money has been borrowed
meaning our form of a debt so now the
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positive defers from the basis of deal
and also to the market conditions at the
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given point of time so however almost
every LBO falls in the range between 30
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to 50% or 40% primarily
borrowed debt from the separate our
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lenders and it usually is between 50 to
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70% the next over here is called
the senior debt
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so what is that see if a private equity
firm you take senior debt you need to
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rank it first okay
because before anything all debt and
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equity you need to be repaid the terms
and condition of this kind of debt are
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also very strict so to take the debt you
need to show forth specific financial
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ratios other to the standard the lender
mentions and the debt is also secured
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against the specific assets of the
company so if the company is in able to
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pay off its debt the lender will acquire
these assets at this that is very much
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secured and the rate of for what we call
as interest for this debt is quite low
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as the private equity firms you can take
this sort of debt 4 to 9 years and
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period and can pay off the debt at the
end of this single payment fifth is
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called the subordinated debt now they'll
LBO financing using the subordinated
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debt stands exactly below the senior
debt and you can take this or that for a
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period of 7 to 10 years and you
need to repay the whole amount in one go
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at the end of the period so this day
comes next to senior debt because in
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terms of the liquidation okay and this
that gets preference after the senior
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debt so the only pitfall of this debts is
that the subordinate it has the high
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interest rate and as this debt is not
secured as the senior debt the risk is
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usually very higher of for the lender
and that's why they charge for the
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higher lending cost than the senior debt
the sixth is called the mezzanine debt
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now this LBO financing through the debt
has the most risk for the lenders and
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that's why it costs a lot more than the
other types of debt so this that stands
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after the senior and unsecured debt
repayment method is bit different than
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the other debts here how it works it
let's say if you take a debt of let's
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say 100 shares in the firm of
measurement that you need to pay 10%
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of the interest every year and
you'll you you will have 5% in
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cash 5% in kind and the later
part of the interest is called PIK that
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means paid in kind and in the 1st year
you will pay for
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was 5% cash and 5% accrue in the next
year along with the 10% of the next
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year's principal amount and this method
will go on until the whole debt has been
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repaid
so mezzanine debt is given usually for
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the period of 10 years or less so you as
a private equity firm needs to pay off
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the debt within the 10 years and
mezzanine debt also includes warranties
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options so that you know lenders can
participate in the equity returns sort
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of thing now how to finance an LBO with
thin assets know what to do when the
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company's assets have been too thin
we'll take an example here let's say
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there is a company called MNC and it has
a pre-tax income of so let's say $1.25
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million dollars okay and the offer they
get is a $5 million so they go
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to the lenders and they try and arrange
is some debt against the asset the only
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problem they have is that they don't
have enough assets to use the collateral
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company MNC has let's say around 2
million worth of assets including
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equipment but still there is a huge gap
of what we call as 3 million so in this
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situation the only option is to finance
the LBO through what we call as cash
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flows for that the cash flows have to be
huge and it should cover the senior debt
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the subordinated debt in the salary of
the entrepreneur so if the cash flow is
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not that big there is no point for which
you should go for the buyout and there
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is another option available if the asset
value is higher than the cash flow and
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the price in some of the assets of the
company which can also be called as
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equipment finance and within the rest
you can run your company so based on
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this let me make my final conclusion LBO
financing is a great business by itself
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if you can buy a great business you'd be
able to make a huge profit out of there
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just by putting in some of your own
money and by borrowing the rest of the
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money in that the only crucial thing is
that you need to take care of the due
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diligence part because that's that is
what is gonna make a difference so you
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need to make sure that before you ever
decide to purchase the company you know
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everything about the company and the
operations the
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product service how the company is run the
senior management and how they make
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decisions so the cash flow coming in
pre-tax income every year and the
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capital structure and the strategy of
the business for the future expansion so
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if you can do a thorough analysis find
it satisfactory the only one you should
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go for as an LBO it's a best better to
invest your money in some other
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investment opportunities that's it for
this particular topic if you have
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