Why buyout a company

Land and buildings. Real property is probably the least complicated asset with regard to its hockability once it has been appraised. Even if the target company has hockable assets, you should be wary of other pitfalls before pursuing the deal. Equally important as the hockability of the assets is whether they are already hocked.

Obviously, when the present owner of a business has already borrowed to the hilt, the lender will be unlikely to allow much more borrowing.

But many owners of closely held small companies conveniently overlook the existing debt when talking price. Of course, it makes a great deal of difference.

The value of a company equals the value of its stock plus the value of its debt. Often the seller wants to retire, so you must find out whether subtraction of debt will leave enough to permit the owner to do so. If the value of debt which most likely your lender will demand be paid off is not subtracted, you as buyer may in fact be paying more than the talking price. I emphasize this point because in the excitement of buying your very own company, you may treat its debt lightly, only to find that the needed financing is not available.

Advice to current owners who anticipate selling the business soon: try to reduce or eliminate secured indebtedness before putting the company up for sale. No turnarounds. True, banks and other institutional lenders have acted strangely on some of the mega-deals you hear about in the press, but for smaller deals, this general statement holds.

For the budding entrepreneur wanting to do an LBO, a healthy company is much more attractive than a turnaround. Too much growth. Since growth eats up working capital, going into a growth situation via an LBO is likely to cause cash flow problems. If your plans for the target require capital outlays for growth, you may need to secure zero-coupon notes or interest-only loans from pension funds or other institutions in order to do the deal.

When a number of potential buyers are eyeing a target company, some of the necessary conditions for an LBO become quite difficult, if not impossible, to satisfy. The biggest threat is a possible demand by the seller for an all-cash deal.

In an LBO, the owner usually takes back a subordinated note to cover the difference between the selling price and the loan. Without someone to take a subordinated note in lieu of the seller a procedure called mezzanine financing , the deal will fail for lack of de facto equity.

Without a compelling reason to sell, an owner creates all sorts of problems for the buyer who wishes to do an LBO. First, the price may be unrealistic. Brokers will often solicit such hypothetical listings. In Los Angeles, hardly a day goes by without a call to the president of an attractive mid-sized company from a broker seeking a listing. By a compelling reason to sell I mean circumstances like serious illness or even retirement at a normal retirement age.

When an apparently healthy person of 40 or 45 wants to retire, you should question the motive to sell. An owner without a compelling reason to sell may be reluctant to accept a note, particularly a subordinated, unsecured note. Some buyers have solved this security problem by offering a second or junior secured position on the equipment or other assets. The impact of this on consumers can vary. If the buyout reduces costs, it could lead to lower prices.

Sometimes, though, the reduction in competition leads to higher prices because the newly merged company doesn't have enough competitive pressure. A corporate buyout can bring efficiency by eliminating areas of duplication between the two companies. This should increase profits by cutting expenses. However, increased efficiency comes at a human cost. When two companies have two people doing similar tasks, one of them frequently is laid off.

These potential mass layoffs can disrupt the lives of people and of communities that have a high concentration of employees working at the companies involved.

Another type of leveraged buyout is a management buyout, which is similar to an employee buyout but requires a smaller group of business leaders to raise the money needed to purchase the business they work for from its owner. An IPO, or initial public offering, is another way for a business owner to entertain the prospect of a buyout.

Unlike other types of buyouts, which an owner can do little to initiate, an IPO is within the owner's control. With an IPO, a business owner registers with a stock exchange and sells ownership shares of the business to members of the general public, including investors and other businesses. While some owners keep shares for themselves, others use an IPO as a form of buyout and sell off the entire business.

The exiting owner will still benefit from a gradually diminishing role in the operation and the freedom to enjoy more leisurely pursuits.

Once the owner is completely out of the picture, the combined entity will have a go-forward plan in place to continue to grow the business, both internally and through acquisitions. In addition, the exiting majority owner will see the value of his or her equity increase if performance benchmarks are reached.

Large companies receive higher valuation multiples from the market compared to smaller companies, partly due to lower enterprise risk. An exiting owner may also wish to convert his or her equity into cash.

This is because many business owners have a considerable net worth, but a lot of this value is often tied up in the business, and thus illiquid. Unlocking this equity through a liquidity event may reduce the seller's risk by diversifying his or her portfolio and allowing the seller to free up more cash. Another common exit scenario involves an elderly owner who is experiencing health problems or getting too old to run the business effectively.

Such situations often necessitate the need to find an acquirer quickly. In the acquisition marketplace, private equity appears to be better suited to quickly engage the owner, assess the business, and complete the acquisition. A reasonably well-run mid-market company can be acquired within three to six months if both parties are genuinely invested in the deal. This is especially true if the exiting shareholder's accountants readily provide yearly and monthly financial statements, and if the acquiring equity group already has the accounting and legal, due diligence team ready to move in.

Family disputes are also a common driver for an acquisition. A spouse or close relative may be abusing company assets for personal gain, resulting in poor company performance and low morale. Incoming investors can get rid of dysfunctional individuals and restore good management practices in the business, as well as provide peace of mind to the seller.

A seller may seek to sell his or her company for operational or strategic purposes. For example, the owner may wish to:.