What is Leveraged Buyout?
A leveraged buyout (LBO) refers to the possession of a company which is funded mostly with debt obligations. Industries and companies of all sizes have been aimed by leveraged buyout transactions. Generally, leveraged buyout involves the use of a combination of different debt instruments from banks and debt capital markets.
Applications of the Leveraged Buyout Analysis
- Analyzing leveraged buyout determines the maximum purchase price for a company. This purchase price can be paid on the basis of certain equity return parameters and leverage (debt) levels.
- A leverage buyout analysis develops a view of the leverage as well as equity characteristics of a leveraged transaction at a particular price.
- Analyzing a leverage buyout calculates the minimum estimation for a business entity as an LBO firm, in the absence of strategic buyers, should be a willing buyer at a price which offers the expected equity return thereby meeting up the hurdle rate of the business entity.
Steps involved in the Leverage Buyout Analysis
The key steps involved in analysis of leverage buyouts involve:
1. Building up operating assumptions and projections for individual companies to reach EBITDA and cash flow assessable for repayment of debts over the investment horizon which is, generally, 3-7 years.
2. Find out the key leverage (debt) levels and capital structure which provide pragmatic financial coverage and credit statistics.
3. Guesstimate the multiple at which the financer is expected to egress the investment.
4. Evaluate the equity returns to the financial sponsor and sensitize the results to an assortment of leverage and egress multiples, in addition to the investment horizons.
5. Work out the price which can be paid to congregate the aforesaid parameters. Conversely, fixed prices work out better for high performance results.
Important considerations in an LBO transaction
There are certain things which need essential consideration. Some important ones include:
- Industry characteristics
These include type of industry, cyclicality, competitive landscape, major industry drivers, and potential outside factors like politics, changing rules and regulations, and more.
- Market conditions
These include accessibility and cost of bank and high yield debt and the expected equity returns.
- Debt ratios
- Liquidity ratios
- Profitability ratios
- Asset management ratios
- Cash Flow Indicator Ratios
- Market value ratios
- Financial analysis
- Business Terms
- Financial education
- International Financial Reporting Standards (EU)
- IFRS Interpretations (EU)
- Financial software