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How Leveraged Buyouts Can Help Small Businesses

ByChris Porteous,
business.com writer
|
Sep 11, 2019
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Leveraged buyouts can help small businesses that may otherwise struggle to attract outside financing.

Small businesses are constantly on the prowl for additional funds, and who could blame them? It's only possible to remain competitive in the modern marketplace if you're constantly investing in your future, and this may mean selling the company, or large swaths of its shares to a third party, in order to get your hands on the financing you need.

Leveraged buyouts are a fantastic option that can help many small businesses on the road to success, yet few entrepreneurs and would-be financiers truly understand them. 

You can't possibly hope to take advantage of a leveraged buyout if you don't thoroughly understand what it is and how it's orchestrated. Your first step should be to comprehensively educate yourself by familiarizing yourself with the ins and outs of the average leveraged buyout. Put simply, a leveraged buyout is when a majority share of a business is acquired using outside capital. A significant amount of borrowed funds that must be repaid with interest being used to purchase a property is the defining facet of a leveraged buyout.

There are many useful examples that you can study if you're still struggling to understand what a leveraged buyout is. Hilton Hotels was famously acquired via leveraged buyout that exceeded $20.5 billion in debt financing, for instance, illustrating that even historically renowned mega-companies can be purchased in leveraged buyouts.

Small businesses can benefit from leveraged buyouts too, however; it would be a terrible mistake to assume that only a massive corporation could be bought out in such a fashion. The major difference between leveraged buyouts centered on small businesses versus those focused on corporations is the amount of debt involved. A massive conglomerate could be worth billions, whereas most small businesses won't be worth anything near that amount. Using a leveraged buyout to scoop up a company by harnessing the power of debt can be a tantalizing investment option, but it also carries certain risks that must be considered well ahead of time.

The market can be defined by risk

If there's one thing that can safely be said about the leveraged buyout market, it's that it's often defined by risk. One of the greatest signs of peril in the marketplace is an ever-growing reliance on extra debt and a low reliance on equity cash. Too many people borrowing too much money at risky levels is a warning sign that too many illegitimate leveraged buyouts are occurring. Small business owners, in particular, should pay careful attention to the return of risky deals to the leveraged buyout market if they're about to venture into it for the first time, especially as economic tensions stemming from the ongoing trade war continue to simmer.

Leveraged buyouts can nevertheless be a godsend to some small businesses. After all, if you're trying to sell your company or a majority of its shares but find yourself incapable of locating a suitable buyer, the leveraged buyout market may be your last chance at securing additional financing in exchange for control over your company. Few entrepreneurs look forward to ceding sovereignty in exchange for cash, but the truth of the matter is that many small businesses need a constant influx of capital to keep pushing ahead in the market, and leveraged buyouts frequently offer that much-needed cash.

In the early days of the leveraged buyout market, it was commonplace for massive corporations to be purchased via leveraged buyout before being split into disparate parts that were then sold for a profit. If you're a small business, however, or a brokerage interested in scooping one up via leveraged buyout, there's a strong chance you won't be able to profit by splitting the company into multiple parts before selling them off to whoever comes calling. For most small businesses, a leveraged buyout likely means a change in leadership when the new leader simply doesn't have enough cash on hand to purchase the company outright.

Know what you're giving away

If you're a small business owner considering a leveraged buyout with a financier, what would you be giving away? If you're the owner of the business, a leveraged buyout effectively means that you're turning over control of the company to whoever is orchestrating the leveraged buyout. In exchange for their debt-financed lump sum of cash, you're likely giving away a majority share of the company or even all of it outright. For an entrepreneur who has established a neat commercial empire for themselves, leveraged buyouts could be a springboard into early retirement if they're content to sacrifice their business in exchange for a mountain of cash.

As the Harvard Business Review makes clear, the market for leveraged buyouts has radically changed over the past decade or so. Once upon a time, a bank or major finance company was usually your only hope when it came to securing enough financing to rely on a leveraged buyout when you otherwise couldn't afford to acquire a company. These days, however, many financing options can be relied upon by clever entrepreneurs who know where to turn to if they find themselves cash-strapped and in need of a loan.

If you're a small business owner eager to sell your shares to an outside financier or an investor trying to scoop up that kind of business, understand that the assets in question are crucially important. If the company being sold via leveraged buyout doesn't have sufficient assets to convince lenders that the entire initiative is worthwhile, not enough financing can be collected to facilitate the sale in the first place. A leveraged buyout that is cash-flow based will obviously need to be centered on a company that has a robust-enough cash flow to convince investors that the operation won't fall apart because of some diminished sales or a local recession.

Know why they're selling

Finally, if you’re buying a company via leveraged buyout, understand why they're selling in the first place if you don't want to end up inheriting an economic headache. A small business can greatly benefit from a leveraged buyout. The old owner can happily retire, the new owner can inherit a budding company via debt-financing despite not being able to personally afford it and the workers get to keep their jobs. If the person selling you their business doesn't have a compelling reason to part ways with their commercial empire, beware that you could be inheriting a struggling business that's unlikely to turn a profit anytime soon.

Leveraged buyouts can reshape small businesses in a number of ways. Whether it's putting a new owner in charge or achieving new levels of financing that can help a company expand, leveraged buyouts regularly display fantastic results for those involved as long as they're orchestrated carefully.

Spend plenty of time determining the overall health of a company before getting involved in its leveraged buyout, but understand that such an arrangement can be an economic godsend to those facilitating it.

Chris Porteous
Chris Porteous
See Chris Porteous's Profile
I'm a serial entrepreneur and owner of three internet ventures, including My SEO Sucks. A contributor to ZeroHedge, Entrepreneur.com, Forbes, Inc.com, and dozens of other media outlets, I believe in SEO as a product. I developed a proprietary technology fueling the #1 rankings of My SEO Sucks clients. In guest speaking ventures across North American, I advocate for organic search traffic as the backbone of any comprehensive digital marketing strategy.
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