While the LBO (financial package) market has been strongly affected by the subprime crisis, it has nevertheless enjoyed a particularly strong recovery over the past two years. Indeed, we note the presence of four operations exceeding $1 billion out of the 220 operations carried out in France in 2015 alone.
This dynamism is due in particular to the possibility that this arrangement provides to acquire a new company with a limited contribution. Indeed, LBO (Leverage By Out) is a financial arrangement that consists in acquiring a company using a leverage effect that will be based on maximum debt. The transaction can then legitimately be compared to a certain extent to a credit purchase.
Brief explanation of the process
The assembly of the LBO can be broken down as follows:
The buyer creates a holding company where he will be in the majority;
The holding company comes into sufficient debt to be able to buy a company called the target;
The holding company reimburses the capital of the debt as well as the interest using the profits generated by the target company.
The leverage effect present in the second stage is obtained by the intervention of external financiers, the objective being to limit as much as possible the investment in equity by the buyer.
The arrangement is therefore most commonly based on the contribution of senior debt (i.e. traditional debt granted by banks), which will be a senior debt and therefore privileged at the time of repayment. If the amount of the loan is too large to be supported by a single bank, it is common for several banks to join forces. The group then takes the form of a syndicate or a banking pool.
Other forms of debt can occur such as:
Mezzanine debt characterized by hybrid securities (OBSA, ORA, OCA, etc.);
Junior debt in the form of high-yield bonds.
These are subordinated debts, which will therefore only be repaid after the senior debt has been repaid. The intervention of these two types of debts is rarer because it is limited to the most important financing needs. Indeed, they make it possible to reach amounts higher than what the banks alone are willing to invest.
One or more leverage effects?
If the financial characteristic of the leverage effect is highlighted in the context of the package presented above, other aspects need to be specified:
Tax leverage effect: For example, the tax consolidation regime is possible if the holding company owns at least 95% of the target company and leads to a possibility of deducting from the target company’s taxable profit the financial costs related to the acquisition debt;
The legal leverage effect: It is then a question of optimizing the financial aspect by choosing the legal form that the Holding Company will take or with the possibility of taking control of a company with very small start-up funds but a cascade of multiple holding companies in order to increase the possibility of debt;
Social leverage effect: A Management Package can be set up to remunerate the company’s management in the form of various securities in order to ensure a common objective of profitability making it possible to perpetuate the financial package.
Although unavoidable in the context of many financial arrangements, the LBO system has often been a target, its detractors accusing it of maintaining increased pressure on employees with the presence of a sword of Damocles that would fall on the company if the profits did not make it possible to honour the debt contracted.
Nevertheless, despite its tendency to put companies into debt, LBOs are a proven technique, both in terms of the profitability observed on its funds and their ability to support SMEs through strong operational leverage.
Finally, the integration of LBOs into private equity seems to increase the democratisation of this arrangement, and to encourage a better integration of private equity in companies with development projects whose ambition cannot be guaranteed by traditional financing.