This week, I’m addressing a thought-provoking question from my viewer, who commented on one of my YouTube videos about buying a business with no money. He believes that anyone with some brains can structure a deal without using their own money—otherwise, leveraged buyouts (LBOs) wouldn’t exist. So, let’s dive into the mechanics of LBOs and discuss whether it’s truly possible for someone with no money to pull this off. https://youtu.be/UrBLOtRY0OI
What Is a Leveraged Buyout?
A leveraged buyout (LBO) is a financial strategy where a buyer acquires a business using borrowed money, with the target company’s assets serving as collateral for the loan. This concept gained widespread attention in the 1980s, thanks to high-profile deals and books like Barbarians at the Gate.
In simpler terms, it’s like financing the purchase of a car: you borrow money to buy the car, and the lender secures a lien on the vehicle in case you default on the loan. In an LBO, the business being purchased effectively finances its own acquisition through its assets.
How Does an LBO Work?
Here’s a step-by-step breakdown of how an LBO deal is typically structured:
The Buyer Sets Up a Purchasing Entity: The buyer creates a new company (let’s call it BuyCo) specifically for this transaction.
Assessing the Target Company’s Assets: The target company (SellCo) owns valuable assets such as land, receivables, inventory, and equipment. These assets are evaluated for their collateral value.
Securing a Loan: The buyer approaches a bank or lender and requests a loan to finance the acquisition. The lender agrees to provide the loan, but only on the condition that they receive a lien on SellCo’s assets post-acquisition.
The Merger: To secure the loan, BuyCo and SellCo must merge into a single entity (NewCo). This ensures that NewCo owns the assets and is simultaneously responsible for the loan.
Closing the Deal: At closing, the bank disburses funds to the seller via a lawyer. Simultaneously, NewCo grants the lender a lien on the assets. This complex process involves meticulous legal coordination to ensure everything happens simultaneously.
Challenges with LBOs for Individuals with No Money
While LBOs are a powerful tool, they are not easy for someone with no financial resources to execute. Here’s why:
Banks Rarely Finance 100%: Lenders typically don’t loan the full value of the target company’s assets. They account for risks by limiting the loan-to-value ratio, often requiring additional equity or subordinated debt.
Legal and Transaction Costs: Even a modest LBO can rack up significant legal fees. For instance, a $1 million deal I was involved in incurred over $10,000 in legal costs due to the intricate paperwork and coordination required.
Vendor Financing: Many LBO deals rely on seller financing or equity participation. Sellers may accept a note or shares in the new entity, but this still requires negotiation and often some upfront capital.
Strong Buyer Financials: Banks often consider the financial strength of the buyer’s existing company (BuyCo). If BuyCo has no assets or cash flow, securing the loan becomes far more difficult.
Can a Person Truly Buy a Business with No Money?
In my previous video, I addressed whether someone who is flat broke could buy a business using 100% borrowed money. The answer, in short, is that it’s highly improbable. LBOs work best for larger businesses with valuable assets and a financially strong buyer. For smaller deals or individuals with no resources, alternative strategies like equity partnerships or creative financing may be more realistic.
Final Thoughts
Leveraged buyouts are fascinating and effective for larger companies with significant assets. However, they require careful planning, strong financials, and expert legal guidance. For those interested in learning more about LBOs and other acquisition strategies, I encourage you to explore my online course on buying a business. It’s a comprehensive, self-paced program featuring videos, workbooks, and updates to keep you informed.
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Cheers!
David C Barnett
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