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Buying a Business with No Cash

The Leveraged Buyout (LBO) — acquire a company using borrowed funds, with the company's own assets as collateral.

What Is an LBO?

A leveraged buyout occurs when a financial sponsor gains control of a majority of a target company's equity through the use of borrowed money or debt. It's a strategy involving the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.

Often, the assets of the company being acquired are used as collateral for the loans, in addition to the assets of the acquiring company. The purpose is to allow companies to make large acquisitions without committing a lot of capital.

LBO Guidelines

The business must meet ALL of the following criteria:

1The business must have been in business for at least 5 years
2The business must be incorporated
3The business must have a Duns rating and a Paydex score of 80 or better
4Two years audited financials with record of growth
5Trained employees and a solid customer base
6Proper equipment and an established inventory

How It Works — By the Numbers

The business costs$1,000,000
Gross revenue per year$2,000,000
Cash flow$600,000

You use the business as collateral for the $1M loan, and the $600K net cash flow to repay it. You should not need to personally guarantee the loan if you follow the LBO guidelines.

Gross income/month$165,000
Net income/month$50,000
Loan payment-$20,000
Net profit every month$30,000

Why Business Ownership Is Better Than Real Estate or Stocks

vs. Real Estate

Many businesses are for sale with real estate and all assets included. You're buying real estate, business assets, AND cash flow. Financing a $10M business with real estate included is easier than financing a $500K house — the business has proven capacity to service the debt.

vs. Stock Market

In the stock market you risk losing money. When you own a business, you only risk not making profit. If you leverage an existing business with all inventory and equipment, your initial investment is minimal.

Due Diligence — The Florida Transportation Story

A real example of why you must investigate deeply.

The author found a transportation company in Florida. At first glance, numbers had dipped from the prior year. But flying out for a site visit revealed hidden value:

  • The facility was being under-used — extra units could be rented out
  • An auto body shop in back serviced their buses AND brought in outside income
  • They were the only shop within 100 miles that fixes tour buses — no new ones being built
  • They had an advertising company serving other area businesses
  • Best of all: a $5M lawsuit in their favor (three buses caught fire due to manufacturer defect)

The lawsuit explained the revenue dip. Without due diligence, they would have missed all the positives.

Seller Financing

Always negotiate for the seller to carry paper (a note) for at least 25% of the business price. Two reasons:

  1. When assets like equipment and real estate are involved, it's easier to get a loan against the assets and have the seller carry paper on the unsecured portion (the business itself). If they refuse — ask why. They may not believe the company can service the debt.
  2. When the seller still has money vested in the deal, they'll do everything in their power to make sure the business succeeds.
Reflect

How could a leveraged buyout model apply to your business? What assets could you acquire using OPM?