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Corporate Finance *Going Private: absence of a public float Two methods of going private: 1- A...

Corporate Finance
*Going Private: absence of a public float

Two methods of going private:
1- A publicly owned company purchased by a private company or a private equity fund.
2- Repurchasing all publicly traded shares from stockholders.

My question is: Leveraged buyout an easy way to go private. Please explain why or how?

Solutions

Expert Solution

PE firm uses LBO to take a current public company into private by buying all of its outstanding shares. The buying firm usually holds the company for a few years to avoid the watchful eyes of shareholders. This allows the buying firm to make adjustments to repackage the acquired company behind closed doors. Then, it offers the repackaged company back to the market as an IPO. When this is done on a larger scale, private firms buy many companies at once in an attempt to diversify their risk among various industries.

A Leverage Buyout is a transaction where a PE firm or a group of PE firms purchases a company using a large amount of debt and putting a small amount of equity.

A successful LBO will be when a PE firm buys a company by using a large amount of debt but over time that company payoff the debt. So, it reduces the PE firm’s debt level, and at the same time equity level increases in that company. So, ten years down the line when PE firm will be going to sell the company, they can therefore increase the rate of return because the equity level of the company has increased.    

The easer way to understand LBO by assuming a scenario, suppose you wanted to buy a house of $500,000 but if you are only going to put down $50,000 as a deposit and borrow $450,000 from the bank for 10 years. If you rented this property out and use the rent income to serve the debt then after 10 years when you will be going to sell this house, at that time you will be able to generate the entire $500,000 amount because there is no longer debt on it.

So, this is a huge rate of return by initial invest of $50,000 and after 10 years getting $500,000. This is how LBO helps PE firms to buy a company using lot of debts and pay down the debt by using the company’s cash flow then sell it down the line.   

LBOs have clear advantages for the buyer; they get to spend less of their own money and get a higher return on investment and help turn companies around. They see a bigger return on equity because they’re able to use the seller’s assets to pay for the financing cost rather than their own.

Steps in a Leveraged Buyout:

1. Build a financial forecast for the target company

2. Link the three financial statements and calculate the free cash flow of the business

3. Create interest and debt schedules

4. Model the credit metrics to see how much leverage the transaction can handle

5. Calculate the free cash flow to the Sponsor (typically a private equity firm)

6. Determine the Internal Rate of Return (IRR) for the Sponsor

7. Perform sensitivity analysis

jeff jeffy answered 1 year ago
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