If you are interested in buying a company but have insufficient cash, a leveraged buyout is an ideal option to consider. Unlike other financing options that target large companies, leveraged buyouts provide you with an opportunity to buy smaller companies by borrowing against the company’s assets such as inventory, receivables, and cash flow. Below, we take a look at what leverage buyouts entail.
Understanding Cash Flow, Assets, and Price
For leverage buyouts to work, the lender relies on three components to provide financing. These include cash flow, assets, and price. While the cash flow ought to be sufficient to service the debt, the assets need to be adequate to secure the loan, and the price is at the proper value to match the cash flow and the assets.
The cash flow often comes in handy in helping leveraged buyout deals service the debt while also allowing the buyer to get proceeds during the company’s operations. Where the assets offer a high value beyond the price and the cash flow, buyers can sell off the assets, with the proceeds helping you reduce the debt. The company can then run on what is left over, with this method of operation commonly known as breakup value.
Be Wary of Pitfalls
While assets such as receivables, equipment, and cash flow can work in your favor, some unforeseen pitfalls could spell disaster during leveraged buyouts. Examples of these drawbacks include:
As is the norm, a company’s value is measured by its debt and its stock. If you deduct the debt and the remainder presents an unfavorable option to the buyer, your leveraged buyout is not worth it.
Too Much Growth
When a company experiences too much growth, a lot of debt goes into working capital, leading to cash flow problems. Investing in companies with increased growth may overload leveraged buyouts due to internal cash flow problems.
Leveraged buyouts can also come with the incentive of attractive turnarounds, an aspect that often masks underperformance. If the recent and past cash flows indicate troublesome operations, no amount of proper management or improved turnaround will help you achieve profitability.
If you need to take advantage of an opportunity in the market and invest in leveraged buyouts, consider reaching out to New Horizon Capital Funding today. We will help you get ahead of one-time opportunities for a successful entrepreneurship journey.