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What is LBO (Leveraged Buyout)? | Features | Example - YouTube
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by clicking the bell icon today we have
a topic with us is LBO leverage now what
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exactly is leverage buyout see well
leveraged buyout is basically you know
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acquiring a company with a small amount
of equity say let's say 5 to 10%
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right off the total cost and
using a debt fund for the remaining 90
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to 95% so this is your equity
portion and this is it debt portion
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right so this implies that you know the
acquisition is done primarily using the
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borrowing phone as you can see
90.95 %with the high
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leverage so the buyer that is over here
it's gonna be the PE firm who is gonna be
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the in charge hopes to earn a higher
return on its investments in the purpose
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of the leveraged buyouts is to allow
companies to make our large acquisitions
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without having to commit a lot of
capital now how does the LBO model work
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see in this section of what is LBO we
will try and understand how the LBO
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works using a simple example so that
afterwards the LBO financing becomes
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clear let's say that you have a business
and it's a great business and there is
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no debt as of now and it generates let's
say a pre-tax income of 1.5 million
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dollar and you it turns the net income
closely it is earning a net income of
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let's say $1,000,000 assuming that you
are paying a third of what you earn to
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the government now over here mr. B
contacts you and praises your enterprise
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and desires to buy the company in
$10,000,000 let's say to you and it's a
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great deal because you have been earning
1 million every year per year and 10
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million looks pretty attractive to you
so you so you agreed for the buyout and
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mr. B on on the other hand checks his
funds and finds out that he can invest
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how much only to the extent of 1 million
but this is the amount he can only
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invest and the rest he has arrange
somewhere else from somewhere else so he
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asks
he goes to a bank and he asked the bank
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to lend him the rest of the amount the
bank disagrees to lend the amount
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thinking that it would be very risky
business then mr. B over here goes out
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and sees that your company has great
assets so he shows the assets of the
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company and uses the assets as
collateral and convinces one of the
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banks to lend the money at let's say 10%
of interest that we per
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Annum basis so mr. so mr. B he invests 1
million of its own fund and what he does
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he borrows the $9 million from the bank
and he pays off in total $10 million okay
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he pays you of $10 million and buys the
business now the business does not
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consist of equity only there is 1
million of equity and 9 million in terms
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of this would be called as the leverage
bout since the debt is used heavily in
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the whole deal right so this is the
composition now we will now check
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whether this deal is profitable to mr. B
or not see after buying the business if we
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assume that the form still generates
let's say $1.5 million in pre-tax income
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over here we had pre-tax income of $1.5
million right here's how the calculation
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will go even if the firm generates $1.5
in pre-tax the net income won't be $1
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million after paying point $0.5 million of
taxes now mr. B needs to pay interest on
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its borrowed of funds so he has borrowed $9 million for 10% right $9 million for 10%
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so that means he needs to pay how much
just make it 10% I'm just doing it
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for you 0.9 right $900,000 has
the interest so that means the company
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has a pre-tax income of how much 1.5 and 0.9
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so you just make this negative you get
point 6 that is $600,000 and he will pay
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the same tax rate as the interest is tax
deductible so he will get a net income
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of closely $400,000 assuming that he would pay 1/3 part of the pre-tax income as
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taxes 0.2 so 0.6 - 0.2 that's
0.4 so that's gonna be the amount but
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this means that if the income remain
similar for the next 3 years he
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would get back to his investment money
and more so in this example mr. B has
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taken the help of a bank and in big
deals usually the company targets the
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competitor what we call as company and
takes help of the private equity firms
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that the private equity firm then goes
out and puts in some of its own fund and
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takes a loan from the financial
institution so let me summarize the LBO
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this section of LBO summarizes most of
the important features of LBO
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let me summarize in a very concluding
fashion let me do it the way it should
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be now over here will be writing two
things first what is the parameter that
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has been used and in which range it goes
even number we here will start with the
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first one saying the return okay the
returns it ranges this so what we are
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discussing is the section of the LBO
summarization most of the important
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feature of the LBO the returns are
normally between 20 to 30%
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generally okay second the exit time
horizon
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exit time horizon means that at what
time they will take an exit position
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from that particular company in their
investment so that is usually 3 to
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5 years ok third the capital
structure
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so what's going to be the capital
structure
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of debt and this will be that will be
high and there'll be equal equity that
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is the private equity firms that they
will invest the equity will be very low
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over here a fourth point not here the
fourth point is the debt payment so the
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debt payment the bank debt that has been
paid usually is in closely to 6 to
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8 years and the higher yield debt
paid in closely 10 to 12 years from
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a 5th point what are the exit multiple
losses that this kind of private equity
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firm used to take the exit position so
they see they're better they see the
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price price to earnings ratio they also
check the EV/EBITDA now multiple
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one of the very important multiple or
the driver that has been used to make
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analysis so it's EV/EBITDA down and
what are the potential exists exits
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potential exits are either sale or maybe
IPO or recapitalization so those are the
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three way the potential exits are been
done so this are some of the very
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important features of LBO that one
should take into consideration while
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investing and beforehand you know they
should be clear about that are they
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falling in this particular criteria
because this is how it's because this is
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how it is going to be around for the
next 2 to 3 or maybe 4 or 5
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years according to the range in which
they are making the investments LBO is a
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very high level business you know the
leverage is going to be high you are
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investing in a risky business I'll give
you one single example
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we all know that we have used BlackBerry
a lot see for blackberry blackberry had
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gone into a turmoil State because of the
revenues got hit because of the
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competitors in the market Samsung iPhone they they had given a strong hit of
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truth to the BlackBerry company so when
it was falling down and there was no
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support the the BlackBerry company was
been purchased by a Canadian financial
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institution they made an investment over
there it's like private equity firm and
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today has been managed by the same
company you know and the leverage has
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been put down on blackberry and they are
able to pretty much survive right now
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they have a good consistency over its
revenue but again there's no surety so
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this is how the LBO model work if you
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