(A) Financing Strategy

Types
Asset-based financing
Asset-based lenders, e.g. banks, financing corp.
Secured floating-rate financing

Senior bank debt

Banks
Unsecured

Fixed-rate senior and subordinated debt

Insurance companies, pension funds, mezzanine
buyout funds
Unsecured fixed rate debt with warrants
1

(A) Financing Strategy

Preferred stock or subordinated debt
Venture capitalists, mezzanine buyout funds,insurance
companies.
Fixed-rate preferred stock with warrants

Common stock
Leverage buyout specialists, venture capitalists, ESOP
Common stock

(A) Financing Strategy

The secured leverage buyout
Loan
Collateral Cash flow
G
B
G
B
G
G
B
B
B
B
B
G

Lenders
Plan
B
G
B
G
-

Small commercial finacing company

Commercail financing company
Every secured lender
Good luck!
Some sophisticated lenders
Money center bank or regional bank
3

(A) Financing Strategy

The unsecured leverage buyout
Securities
Short or intermediate terms
senior debt(2- 6 yr.)
Long-term senior and
subordinated debt (5-15 yr.)
Preferred stock(5-20 yr.)
common stock

Lenders
Commercial bank
Life insurance
companies,LBO funds
Life insurance companies,
venture capitalists
Life insurance companies,
venture capitalists,investment
bankers
4

(A) Financing Strategy

Venture capitalists in LBO
When to consider venture financing

Value added
Creditability with seller
Assistance in financing arrangements and negotiations
Cross-utilization of talent

(A) Financing Strategy

Venture capitalists investment objectives

Expected returns (35%~50%)

Liquidation expectations (5 yrs~7 yrs)
Put option (protective device)
Restrictions on Owner-Managers liquidity
Rights of first refusal
Take-along agreement
Right of first offer

(A) Financing Strategy

ESOP in LBO
Function

Raise additional capital

Recapture taxes
Assure estate liquidity
Retire outstanding shares
Provide a market for closely held stock
Discourage unionization
Buy out dissident stockholders

(A) Financing Strategy

Acquire other companies

Combat tender offers
Broaden the appeal of unions
Shelter excess accumulated earnings
Refinancing existing debt
Maximize IRS investment tax credit
Divest subsidiaries
Purchase key main insurance

(A) Financing Strategy

ESOP invests in the securities of the employer
corporation and is permitted to borrow money.
(Leverage ESOP)
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De men
pay

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ESOP
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n

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at i
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ch

Corporation

Bank
guarantee

(A) Financing Strategy

ESOP is integrated in the financial plan of LBO

Cash flow
Debt amortization
Purchase stock
loan

10

(B) Corporate policy

How risky are LBOs?
Highly leveraged, increase failure
(Thatcher
Glass LBO)
Over-leveraged, bad loan, junk bond
(Dr Pepper LBO, 3 times net worth)
Overpriced
LBO failures (5~15%)
(Eli
Witt, Oppenheimer & Co.)

11

(B) Corporate policy

Why owners should consider a LBO?
For the closely held company, a LBO can
provide the selling shareholders with benefit
that are not fully appreciated.
Liquidity for stock, market stability
Diversification
Family estate tax savings
Reverse LBO
12

(B) Corporate policy

Why management should consider a LBO?
Opportunity to create personal wealth
Conflict of interest (stand on buyout side)

13