How to work a Leveraged Buy Out or LBO - How to Buy a Business - David C. Barnett

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Wayne tells me that ‘any idiot’ can put a deal together to buy a business without using their own money otherwise ‘leveraged buy outs’ would not exist.
This week I’ll explain to you what a leveraged buy out is, how it works, and we’ll see if a person with no money could actually pull it off.
I know that you’re all anxious to find out if you’d be an idiot under Wayne’s definition.
It’s all in this video right here: • How to work a Leverage...
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[@Zachus]

Lawyers and CPAs will work on a contingency of the deal closing. I know this because I've engaged them with some deals I'm working on.

[@DavidCBarnett]

Sure, I guess it's up to them to decide how they'll be paid. In my experience, when they move to contingency billing they move from fee for service/hourly to a percentage of the deal. Much like lawyers with personal injury.

[@successfulone33]

Zachus would you be interested in sharing the names of whom you worked with. If you can email me at [e-mail] Thank you

[@nathanlindley]

David, I just discovered you and am LOVING these videos! Totally binge watching! Can you do some videos on success stories? I don't know anyone who has ever purchased an existing business, but know several people who have been scammed. Can you (obviously without breaking any confidences) tell some success stories or some "Watch out for this!" stories?

[@DavidCBarnett]

Have you seen Ralph and Lucy's story? kzbin.info/www/bejne/gna5lYqGh9GZedk

[@CatoQassem]

There’s a biz that I’m eyeing with an asking price of $4M Has real estate-the land and buildings the plant sits on Something tells me this is the route to go with it

[@warnegoodman]

very clear and concise explanation, thank you for this

[@DavidCBarnett]

Cheers.

[@vipindubey8219]

Thank you sir , the way you explain is awesome Just want to know about all type of buyout ,if its possible then please make a full video on buyout

[@DavidCBarnett]

The other types of buyouts would mean you raise money in other ways and buy the business. 'Leveraged' simply implies using the business' assets as collateral.

[@ramirras]

Legal fees "can" be done on a contingency basis. Of course, most attorneys want to be paid up front but there are some of there that will do things and get paid at the time of closing. They'll charge more to do this but it's worth it, especially if you have no money to put towards the deal in the first place.

[@DavidCBarnett]

Other people have mentioned this to me. I've never seen an attorney do it. I suppose if they were your buddy then maybe you could get a great job done on contingency, but more likely you'd have to find a lawyer with time on their hands to invest in your deal. An attorney with time on their hands is likely a new one or one that hasn't developed a clientele to keep them busy all the time... then I'd worry about quality and experience. But if I weren't putting any money into the deal, then would I care about that? There's lots to think about.

[@longfordboy2538]

Nice job! I actually understood this. Thank you

[@DavidCBarnett]

Thanks

[@HandsOnRealEstate]

Great explanation

[@DavidCBarnett]

Glad it was helpful!

[@YCHHUNTOEKOfficialMUSIC]

Thank you Sir, your explanation is very clear

[@DavidCBarnett]

You are welcome

[@mandelbro777]

Great conceptual explanation. Cheers

[@DavidCBarnett]

Thanks EWO.

[@boyd2free]

How about developing lines of credit first, (1) find a deal with equipment land etc, find the liquidation out the liquidation value (2) Offer that as a downpayment (3) find an asset bank and tell them you are going to pay cash for the business and would like to know if they would refinance, buy/ lease back etc, ask for a letter of commitment from them, then take letter to your bank or a bank that understand the business you are trying to buy, see if they will lend you that money for a day for a certain amount of interest or find a private lender to do what is called transactional loan. use your line of credit to pay the interest payment. Have the seller put a lien against your new llc for security. Do you think this would work of course the business has to cash flow in order to do this

[@DavidCBarnett]

That's very complicated unnecessarily. Here is the problem with this deal at the end of the day: You would have an equipment loan and a vendor loan adding up to the total purchase price. -or- the business purchase price would be equal to the liquidation value of the equipment (probably not a good business.) The different lenders and money movements don't add any value as I understand your question. If the 'asset bank' would lend on the equipment then they would simply advance the money to the closing table. This would give you an opening balance sheet with 100% debt and no equity. Banks have certain requirements for debt to equity on their clients balance sheets. This is critical in managing risk. The exception to this is lenders who will do what is called 'debtor in possession' financing. They really only care about the equipment, they lend very little against it and usually own their own auction facilities. It's for companies in desperate trouble and not usually for acquisition financing. Most buyers need to get as close to fair market value for the equipment financing and this usually means using a regular bank with government small business program guarantees. Most of the time this may only be 75% of the equipment's Fair Market Value. Those DIP lenders may lend 50% of liquidation value. Sometimes we can get some of the vendor financing to be viewed as equity if, for example, the vendor agrees to take no principal payments for 5 years but I haven't seen any banks willing to do this for all the equity. If you developed a personal line of credit and used that as your down payment it would appear as equity on the company balance sheet but most banks would want to know the source of the money and if they learned that it was borrowed they may also not consider it true equity. Here's another question, if the seller was going to agree to a large vendor loan, don't you think he'd want to be the lienholder on the equipment? It would be better just to ask for 100% seller financing with the seller putting a lien on the equipment. -AND- if they did agree to 100% financing, they likely would not be lending you the operating capital so you'd still have a problem of finding money. Did you watch the video about buying a business with no money? kzbin.info/www/bejne/hIe3mHeKbKiWaMk if not you may find it interesting. Of course, to learn much, much more, go to www.BusinessBuyerAdvantage.com and sign up for my online course. Dave

[@danykurniawan12345]

I have been looking for this specific explanation. Thanks

[@DavidCBarnett]

Glad to be able to help.

[@yuszakmahya]

Thank you for your explanation. I have some questions. how to calculate the value of "sellco" at the time of LBO transaction? Will the bank only look at its tangible assets for funding appraisal? What if the seller calculates the company's value in excess of its book value?

[@DavidCBarnett]

Hi, thanks for the questions. You should spend some time on the channel as these are all in-depth topics that I've made other videos about over the years.

[@olitemps2131]

This was really useful. Great video! Thanks for the content

[@DavidCBarnett]

Glad it was helpful Oliver!

[@rakshithshetty9889]

Thank you David

[@DavidCBarnett]

No problem, I hope it was helpful.

[@AaronSmith-rk4mn]

It’s hard to do the way you explained in this video. The best bet is to find a seller willing to sell using seller financing, then you leverage the assets for the DOWNPAYMENT.

[@DavidCBarnett]

Before owning them?

[@blackjesus9641]

Sorry, complete newbie here. Why are LBOs typically used for bigger deals? Can they not be used to acquire medium sized firms?

[@DavidCBarnett]

The legal stuff is just expensive and most smaller firms are bought in an asset purchase. It's simpler and cheaper. Keep in mind that this is a small business channel so the terms I use to describe deal sizes is from that perspective.

[@michaeltabet9223]

You can you need to get LPs on board. (Preferred share holders)

[@DavidCBarnett]

See my playlist on equity financing.

[@marcosj.ferreira]

David, where is part 1 and 2 of this series: 'buy a business with NO MONEY' as you have mentioned to Wayne??? Please send the links. Thank you.

[@DavidCBarnett]

Hi Marcos, there are even more now so I made a play list awhile ago. kzbin.info/aero/PLqomziNDpylV1eSqc_sw8M_anu9nZKodc

[@jasonc4486]

Even if you got collateral you still have to pay the down payment right ? How do you pay for it ?

[@DavidCBarnett]

With your money.

[@ramirras]

I do have one question... When doing an LBO where real estate is involved, like in your example, will the finance company treat the deal as a real estate purchase or will they incorporate the land as an asset and lend a percentage of the value? I know if it is treated like a purchase, the bank will want the buyer to pay about 20% of the value, which can be a lot of money out of pocket.

[@DavidCBarnett]

Typically they'll treat the real estate as a separate asset. So they might finance 80% of the real estate, 75% of the equipment, 50% of the inventory, etc. depending on their policies, etc. Sometimes the different parts are financed by different players. You could even have another party buy the real estate and lease it to you with an option to purchase later if you wanted to leverage their capital.

[@brandoncostner7437]

Where's the video on Subordinated debt?

[@DavidCBarnett]

here: kzbin.info/www/bejne/hoDUiICeZ5yEsMU

[@lifeofry6034]

Couldn't one use a contingent based advisor? So that the fees can be paid by the newly acquired company?

[@DavidCBarnett]

I've made videos about this before. Find all the 'no-money' videos here: www.investlocalbook.com/p/buy-business-with-no-money.html

[@gimmick1974]

Fascinating! Thank you for making this video.

[@DavidCBarnett]

No problem Jim. Send in any questions so I have material for future videos...

[@jasonc4486]

How about the down payment ? How do you pay for it ?

[@DavidCBarnett]

With your money. Or by borrowing against some other asset you own like your house. If you think you can buy a business using none of your own money, watch and read all the content on this page: www.investlocalbook.com/p/buy-business-with-no-money.html

[@lilrockenator]

You mentioned that the purchasing company has to already be profitable and have a strong balance sheet to secure a loan... But is it possible for a newly-formed company to achieve this acquisition / merger?

[@DavidCBarnett]

It just depends who is behind the new company. Most acquisitions use a new entity to perform the deal but the loan decisions may be made based upon guarantees that come from the buyer or another company.

[@manuelcaetanora]

Would you call this "merger" a Special Purpose Vehicle?

[@DavidCBarnett]

No, special purpose entities are usually about managing risk. Whenever you see a term like that used by someone, you should ask what they mean. In the broadest sense it can be any entity with a narrowly focused purpose. In this case we have a new entity which will go on to become an operating company so i wouldn’t say it’s special purpose. If they were also buying a property which had potential pollution issues and they decided to create another corporation just to own the property in order to isolate the main business from potential cleanup costs, this would definitely be a SPV or SPE.

[@matthewmitchell60]

Mr. Barnett thank you for responding i have a question that effects my entire business i also buy and flip real estate and the one big problem i have and the problem i would have buying the flower shop i sent you and that is when private funding is turned down because im not a seasoned investor how am i to get the experience they want if no one will even give you a chance how to get them to fund my deals.

[@DavidCBarnett]

It's not always ownership experience that's needed, sometimes management or sales experience in an industry will give bankers and investors confidence. Sometimes owning a related business will help.

[@coreyburns7744]

👍Video !

[@DavidCBarnett]

Thanks! 👍

[@simfinso858]

Nicely Explained

[@DavidCBarnett]

Thanks Sandeep. Don't miss out on future videos by signing up for my email list at www.DavidCBarnett.com

[@densfloar]

How would you recommend learning about the different deal structures in my home country - Poland. Or most of the deals are the same regardless of the country?

[@DavidCBarnett]

The basics are the same around the world but you need a local attorney to help make sure the mechanics would work in Poland.

[@kuldeepsingh-dp2fq]

Sir please explain the term management buyout

[@DavidCBarnett]

A management buyout is when the managers in a business buy it from the owner. Thanks for watching and keep the questions coming. Sign up for my email list at www.DavidCBarnett.com

[@bingboong7639]

What if it is just an individual doing the LBO and not a company? also, why not just over finance for how much the lawyer/accountant fees are and do a swing loan? For example... 1. Business is listed for $2M 2. Business assets at 70% LTV are $500k 3. Seller wants $400k down 4. Bank approves $500k (when assets are pledged) and is willing to do a swing loan to pay seller $400k leaving $100k in working capital once assets are pledged the same day the business is bought. 5. $100k in working capital then used to pay any lawyer/accountant fees, ect. obviously these are rough numbers and are dependent on many things. But wouldn't a deal structure like this be possible? Assuming this individual had secured the confidence of the initial bank.

[@DavidCBarnett]

You're describing an asset purchase. If you borrowed the money then you would have to pay it back. The 'buyco structure' makes the loan payments from 'before tax dollars.' In the structure you describe, you'd end up with an opening balance sheet with a 1.6M seller note and a 500K bank loan and less than $100K of cash after you pay the specialists. You'd have a debt:equity ratio of about 2,050,000:0 in a world where most bankers like to see 3:1 or maybe more if government programs are at play. Spend some time over at this page: www.investlocalbook.com/p/buy-business-with-no-money.html

[@bingboong7639]

@@DavidCBarnett Assuming the individual would take over the company. I forgot to add the EBITDA in my statement. Say the EBITDA was $700k yearly. Full financing @ 10% interest at 20 years is about $230k yearly. DSCR is about right at 3. (Also assuming the seller has no debt of its own) Would this make a deal structure like this more feasible? Or am I just way off in my thinking here? Thanks!

[@DavidCBarnett]

@@bingboong7639 DSCR is just one thing the lenders consider. They also consider the buyer experience, contribution and the debt:equity ratio. Also, I've never seen a 20-year business loan unless it was essentially a mortgage on a property. If you want to see an example of a real no-money down deal from a person with no assets, go to that page I referenced above.

[@bingboong7639]

@@DavidCBarnett thank you for your input and expertise!

[@densfloar]

Amazing content BTW!

[@DavidCBarnett]

Thanks Dominik! Glad you're enjoying them.

[@lolegacyyy]

Thanks!

[@DavidCBarnett]

Glad you enjoyed it Lo.

[@dk6807]

There is also another way using seller finance.

[@DavidCBarnett]

Yup, there's lots of videos on that on this channel.

[@rajeshwarsingh701]

How To cuting of lbo Sir

[@noneofyourbusiness792]

How about over financing the deal? If the asset value is high enough to leverage.

[@DavidCBarnett]

Why would a seller sell you his business at a discount to the value of the underlying assets? Also, you would still need to hit the bank's debt to equity requirements on the opening balance sheet.

[@noneofyourbusiness792]

David Barnett because some sellers get to a point of retirement. Some of them can’t pass the business on to their kids because their kids aren’t interested. So they end up stuck with their business or they are forced to close the business up. The thing they don’t want to do is close the business up because it closes the jobs out on their employees. Some sellers are sick so all they care about is selling the business right away. In some cases it’s not about money anymore but passing on the business to someone that can keep the business going. Even if the banks finance the deal 80 percent. That’s 80 percent of the FFE/inventory value. The asking price could very well be much lower than the asset value being leveraged. Getting that 80 percent of the loan is when you ask the seller for seller financing to pay that 20 percent. The seller may actually be able to give you 20% maybe 30% maybe even 50% of seller financing. You could also purchase 80 percent of the shares of the business and buy the 20 percent at a later time. To solve the debt ratio issue is a matter of finding a business that is producing enough or more than enough cashflow to cover the debt out of loans and seller financing while meeting requirements of the debt ratio. It’s not impossible. Another thing to consider is when is a great time to seek out a lender. If a lender is not in lending mode of course you’ll meet resistance. Another thing is most cases you’ll get shut down by a lender because most people don’t even know to ask a lender what their lending limit is on each deal or even the banks lending limit to all clients for the year. You also catch a bank in good timing. Good timing is when a bank just opened up and you’re their first customer. Another time is right before the year ends. If a bank says no to you you find a bank that will say yes. Because when a bank says no to you then you didn’t give them enough reasons to say yes. Last thing to consider is that as long as you hit that debt ratio in the right place you can over finance provided you have the down payment ready which you can set up that with the seller through seller finance. Not all deals are the same. Not all businesses are the same. Not all businesses feel the same. A bank may have policies but ultimately the one in charge will make the decision to give that loan out.

[@DavidCBarnett]

@@noneofyourbusiness792 In my experience handling hundreds of deals, prospective retirees are actually the least motivated of the different types of sellers. You're focusing on a hopeful plan that requires many stars to align rather than working on a method that works every day. I've met plenty of people who've wasted years searching for a unicorn deal when they should have been hustling, saving and working on their skills to enter the market from a position of strength.

[@noneofyourbusiness792]

David Barnett it’s not a unicorn deal. It’s not easy but it’s not a unicorn. Those deals do exist. Unicorns don’t. People have done these deals. As far as searching that is what should be done. You never give up searching no matter where you are at. From zero to a hundred businesses acquired.

[@mangesh6661]

How do hostile takeover work when companies have too much equity?

[@DavidCBarnett]

Hi, a hostile takeover is when a buyer buys up enough of the common stock to dislodge the board and take control of the corporation. This can only really happen in a publicly traded company. Most small businesses are family owned and 'acquiring control' would be hard. Not sure what you mean by 'too much equity' as a company can have no debts and all equity. It would mean a poor performance with respect to the shareholder's rate of return on their capital but it would make a solid company that could withstand downturns as they would have no debt. One way to get control of a private company would be if they had too much debt and you were the major creditor. You could force them into bankruptcy and potentially end up controlling the assets. This might make an interesting video.

[@cesar5478]

Is a leverage buyout the same as a structured buyout?

[@DavidCBarnett]

You'd have to ask the person who used the term. It could mean a lot of things about the way the deal is being done. Every buyout has a 'structure' of some kind. Financial people often like to sound smart and make you feel like you don't know anything. Sort of like the Mages of Old. ;)

[@iamjaycrew]

what if sellco has a bunch of debt already?

[@DavidCBarnett]

You could try to make an offer to assume the debt but the problem for most smallbiz deals is that the debts are personally guaranteed by the current owner and sometimes you can't switch the guarantor. Adding you is not usually a problem but the seller doesn't like to leave while still being liable in my experience.

[@iamjaycrew]

@@DavidCBarnett what if they just pay off the debt in the deal in large lump sum?

[@DavidCBarnett]

That's what most sellers want to do when you buy the business, pay off their debts and leave with the balance. In an LBO, the lawyers job is to make sure that at the end of the deal, the buyer's lender has the necessary liens and mortgages in place and that nobody else has a claim on these assets, so if there was another lender there already, the lawyer would make sure they were paid out.

[@iamjaycrew]

@@DavidCBarnett yea were the seller and looking for a buyer and take off the debt in the buy and not sure if the debt is hurting our price and the fact that it needs to be paid in the sell

[@DavidCBarnett]

You should arrange a quick call on Clarity so I can discuss your specific case www.Clarity.fm/davidbarnett cheers

[@HundalCPA]

Does management buy out works the same way!!!!

[@DavidCBarnett]

Management buy out simply means the buyers are the managers. The actual deal format can vary depending on what is worked out with the seller.

[@matthewmitchell60]

Mr. Barnett there is a flower shop for sale that does good business the seller is motivated for health reasons she Is wanting $100K I asked her about owner finance she wants some money up from but hasnt said how much I dont have any money of my own. The property needs about $15k in repairs and I would like some operating income. How would I get private money to fund the deal and make payments to seller & funder and be able to pay the workers and daily activity and make a profit how would you stricter a deal.. I think she would take less on a all cash deal if some funded the whole thing.. I'm thinking about $65-75k maybe not I havent made the offer because I'm not sure if some one would fund me I would be keeping people that has worked for her for years so the business would continue to run.she is putting it up for auction in the next 30-45 days. How would you put this deal together and where to find some one to private fund the deal. She has been in business same location for 30 years. Any help would be great thank you

[@DavidCBarnett]

Hi, I can think of a bunch of strategies but would need more details. This would be perfect for a quick call. You can schedule me at www.clarity.fm/davidbarnett

[@kgomotsokgaboesele5150]

Can a LBO be used to acquire a minority stake

[@DavidCBarnett]

A bunch of minority investors could use an LBO to buy out an entire business. If you were going to join the current owner as a minority investor, then it would look differently. For example, the current owner could leverage the company themselves and take cash out, thus reducing the value of the equity, then you could buy your minority stake from them at a reduced price.

[@orlandoyork2587]

Is this similar to what Disney did with Marvel?

[@DavidCBarnett]

I'm not aware of the details of that transaction. Sorry.

[@jzk2020]

Isn't it technically a Leveraged Buy In? Tell us more about equity partners please :) ... can you have a bank become a equity partner ? Or some other form of partnership with a bank?

[@DavidCBarnett]

Hi C. Lincoln, It depends who you talk to. Wikipedia and Investopedia conflict on the definition of LBO for example. I've always seen Leveraged Buy In refer to a deal where someone was using debt to buy an equity stake in a business but the current owner was staying on as a partner. 'Buying into a company.' Whenever someone starts using a term like LBO or LBI with me, I always stop them and ask them to explain exactly what the foreseen operation will be. There are a lot of different ideas out there and terms can vary depending on where in the world someone studied, for example (UK vs. Canada vs. USA even accounting terms can be different) The gist of this video is simply that it doesn't matter what assets are in a company, a buyer will not be able to get 100% financing on all of them and find someone to lend on the goodwill. The 'LBO' operation I describe is the method that you can pledge a target company's assets to a lender while doing a share purchase deal. cheers.

[@llyg4848]

Why would toys r us have done an lbo?

[@DavidCBarnett]

The question is not why would Toys R Us have done it, but rather why the people who bought Toys R Us did it. They did it because they tried to buy the business with borrowed money. It's a great case as to how a lot of debt can be dangerous.... here's a news article about it. www.bloomberg.com/news/articles/2018-03-09/toys-r-us-downfall-is-ominous-reminder-about-debt-laden-deals

[@llyg4848]

David Barnett true thanks for the response, sad to have seen such a thriving business go under because of the lbo.

[@Frayco-king]

Here come all the QLA’ers who don’t QLA

[@DavidCBarnett]

It's true, I'm a huge Quidditch League of America fan but I don't play the game myself. ;)

[@gautamsane1499]

This model is essentially giving legal passage for business corruption by allowing the interest to be tax deductible. Removing that level of risk from the buyer is grounds for uncontrolled greed without any of the accountability when acquisitions go bankrupt. And let’s not forget the HUMAN BEINGS that play role in keeping the “acquisition” successful every day, what happens to them after bankruptcy?

[@DavidCBarnett]

Interest on business loans is always tax deductible if the debt is within a business. The loans in these deals are almost always personally guaranteed by the buyer. When these businesses go bust, the buyers often go bankrupt as well. To your point, too much debt is definitely dangerous and if a business fails there is certainly a human cost.

[@gautamsane1499]

David Barnett thanks for the reply. Not a business major, got here after watching episode of Patriot Act with Hasan Minhaj 6/7/2020