The Juslaws Taxation Practice assists clients in structuring leveraged buy-outs (LBOs) and provides advice in related tax planning considerations.
Successful LBOs can create value for a number of parties. For example, a company’s shareholders can earn significant returns and post-buyout investors often also earn large returns in the period from completion of the buy-out to an initial public offering (IPO) or resale.
Another potential source of value in an LBO transaction is the wealth transferred by means of tax advantages. After the completion of an LBO the increased debt the new company services decreases its taxable income, meaning lower tax payments. This interest tax shield acts to enhance the company’s value.
The purpose of an LBO is to allow an investor to acquire a target company without having to commit a lot of its own capital. Typically, an investor – often an institutional investor – acquires a significant percentage interest in the equity of the target company through leverage, or borrowing. The assets of the acquired company are used as loan collateral. Generally in an LBO a combination of various bank and debt capital market instruments are used to make the acquisition.
Although companies of all sizes and representing all industry groups have been targeted in LBO transactions, considerations taken into account in evaluating a target include the level of existing debt as well as the ability to make regular loan payments after the buy-out is completed. Some features that make a business an attractive LBO target include –
- Low level of existing debt
- Historically stable cash flow
- Potential for operational improvements to increase cash flow
- Assets that may be used as loan collateral
- Market conditions creating a low valuation or stock price
The LBO process involves institutional investors or private equity firms structuring large deals without committing the total amount required to make the acquisition. In order to accomplish this, the financial sponsor raises acquisition debt securing a loan or issuing bonds. The debt is ultimately secured by the assets of the acquisition target. The target’s cash flow will be used to make principal and interest payments on the loan.
Commercial or investment banks generally finance larger LBOs by issuing syndicated loans and high-yield bonds, whereas smaller deals are often financed using subordinated debt instruments secured by company assets.