Leveraged buyout, also known as financing M&A, refers to the acquisition of a target company by increasing the company's financial leverage to obtain funds and use the cash flow of the target company to repay debts. Generally speaking, in a leveraged buyout, borrower funds account for 70%-80% of the total acquisition funds, and the rest comes from own funds. Companies formed through leveraged buyouts generally have a debt ratio of more than 85%.

◆ The main features of leveraged buyouts

First of all, under the leveraged buyout model, most of the acquisition funds come from borrowing, and the enterprise only needs to provide 10%~15% of its own funds. The acquiring company can use the acquired company's funds or cash flow to repay the loan, and the acquired company pays its own selling price. The acquiring company does not assume any obligation to the loan except for its own funds to be invested, and the creditor can only seek compensation from the acquired company. In order to obtain preferential repayment, the lender can insure the funds of the acquired company.

Secondly, in the leveraged buyout model, because the financial leverage ratio is very high, it is very suitable for small and medium-sized enterprises with insufficient funds and poor financial resources. In addition, the liabilities arising from the financing of the acquisition of poles are relatively high, and the interest expenses can be deducted before tax, so that the tax income base is significantly reduced.

Some companies opt for management buyouts in order to avoid conflicts with shareholder interests and reduce agency costs. For management buyouts, leveraged buyouts are one of the most frequently used financing methods, and the company's management will obtain loans through banking institutions or credit investment institutions.

◆ Practical operation of leveraged buyout

While leveraged buyouts are ideal for undercapitalized SMEs, for most SMEs, using leveraged buyouts to raise funds is not straightforward. Because 70%-80% of the funds for leveraged buyouts come from borrowing, and the main body of loans in China is banks, small and medium-sized enterprises face many difficulties in obtaining bank loans.

In the face of loan applications from small and medium-sized enterprises, banks will conduct a comprehensive assessment of their operation, operation and management, profitability and market competitiveness. Only through an appraisal can a company obtain funding to complete a leveraged buyout. Therefore, to some extent, leveraged buyouts are both a means of financing and a purpose of financing.

Leveraged buyouts, like other buyout methods, focus on some of the characteristics of the company being acquired.

(1) The acquired company has a stable and continuous capital flow and a low asset-liability ratio. Because most of the acquisition funds are borrowed from borrowing, the acquiring company will take the lead in considering the cash flow and debt-to-asset ratio of the acquired company. The acquired company's stable cash flow and low asset-liability ratio will motivate the acquisition of the acquiring company.

(2) The management is experienced and has a large space for cost reduction. After the completion of a leveraged buyout, the acquiring company has to use the cash flow of the acquired company to repay the loan. The experienced management can ensure stable cash flow, and the greater room for cost reduction can make the acquiring company more profitable. In addition, if some non-core divisions or properties of the acquired company are easily sold, they can be sold if necessary in order to obtain funds quickly.

Before deciding to carry out a leveraged buyout, an enterprise must fully consider the above two aspects, make a scientific judgment on the feasibility of the leveraged buyout, and make a scientific assessment of the value of the acquired enterprise. After deciding to carry out a leveraged buyout, the acquiring company should evaluate the assets of the acquired company, and after deciding to make the acquisition, it must make every effort to raise funds to complete the acquisition.

In the process of leveraged buyout, enterprises face certain risks, including the risk of insolvency, the risk of changes in shareholder returns, etc. The acquiring enterprise must make accurate judgments about these risks and take effective measures to control them.

Profit is the fundamental purpose of a business. In the market economy environment, if enterprises want to gain a firm foothold in the fierce market competition and achieve better survival and development, all kinds of economic activities must be aimed at profit. In order to be profitable, companies must think holistically.

The main purpose of a management buyout is to clarify the property rights of the enterprise and to motivate the management. However, a study of a number of management buyout cases in China shows that the transfer price is lower than the net assets per share. In order to regulate management buyouts, the State-owned Assets Supervision and Administration Commission (SASAC) issued the "Opinions on Regulating the Restructuring of State-Owned Enterprises", which basically stopped management buyouts. Because in real life, whether a management buyout can be successfully completed depends largely on the relationship between the company and the local government. If the company has a good relationship with the local government, in addition to the low-price acquisition, the management can also use the share dividends obtained after the acquisition to repay the loan in installments.

Most of the funding for leveraged buyouts comes from bridge loans. After the completion of the acquisition, the enterprise will obtain a loan through the stock pledge of the listed company to repay the bridge loan. In this case, the stake held by the management is very volatile, and there is a possibility that its stake will change if the management is unable to repay the loan on time.