What is a leveraged buyout of a small business?

The word leveraged simply means borrowed. In a leveraged buyout, the buyers use debt for most of the purchase and rely on the business itself to carry it. For a small business this usually means a loan from a bank or a government-backed lender, sometimes with the seller agreeing to be paid later. The idea is easy to state. The risk deserves attention.

How the debt gets repaid

The loan payments come out of the business’s cash flow after the buyers close. That means the same earnings that fund wages, rent, suppliers and tax also have to cover the lender. Buyers who plan this well build a monthly picture of cash coming in and going out, and ask whether the business still works once the new payments are added.

Why lenders look at cash flow and assets

A lender in this setting is judging whether the business can service the debt, and what it can claim if it cannot. Expect questions about financial history, customers, key people and any security offered. The lender will set its own terms, and you should ask each lender directly, since lenders differ. A lender may also want the buyers to put in some of their own money.

What happens if earnings dip

Borrowed money does not shrink when sales do. A weak season, a lost customer or a rise in costs can squeeze the buyers quickly, and a lender may have rights if payments are missed. Many buyers keep a cushion and agree with the lender in advance how problems will be handled. Your lawyer and accountant can explain what the loan documents would actually require of you.

For where the money can come from, see how managers can fund a buyout they cannot finance alone and whether BDC can finance buying a business.