Leveraged buyout: acquiring with financial leverage

A leveraged buyout (LBO) is the acquisition of a company financed largely with debt, then repaid out of the cash flows and assets of the acquired company. It is the typical instrument of private equity funds, but also of managers who take over the company they work for (management buyout) or of entrepreneurs who want to grow through external lines without tying up all their own capital. Leverage amplifies returns, but it also amplifies risks: understanding its mechanics is indispensable before signing.

How leverage works

The idea is simple: if you acquire a company for CHF 10 million by putting in CHF 3 million of equity and CHF 7 million of debt, and you resell a few years later for CHF 14 million after having repaid the debt, the return on equity is far higher than what you would have obtained by paying all in cash. The debt acts as a multiplier.

The flip side: interest and instalments must be paid regardless of performance. An LBO holds up only if the target company (the target) generates stable and predictable cash flows, sufficient to service the debt with a margin of safety.

The typical structure

An LBO is almost always built around a special-purpose vehicle:

• NewCo (acquisition holding): the investors set up a new company — often an AG — which raises the equity and takes on the acquisition debt.
• Purchase of the target: NewCo buys the shares of the target company.
• Senior and junior debt: bank financing (senior, secured) can be flanked by subordinated or mezzanine debt, more expensive but flexible.
• Merger (debt push-down): NewCo and target are often merged to bring the debt closer to the cash flows that must repay it.

The quality of the target matters more than anything: solid margins, low cyclicality, few mandatory investments, a management team capable of staying.

The Swiss legal limits

Here prudence is needed. The acquisition debt is generally repaid with the resources of the purchased company, but Swiss law sets guardrails to protect creditors and capital.

• Capital protection: the target cannot freely distribute or pledge its own assets in favour of the acquirer beyond the limits of distributable profits and reserves. “Upstream” guarantees (from the subsidiary to the holding) are permitted only within precise margins, so as not to breach the prohibition on the repayment of contributions.
• Post-acquisition merger: the merger between the indebted NewCo and the target must be analysed in the light of the rules of the Merger Act, which protect creditors and prohibit operations that hollow out the substance to their detriment.
• Duties of the board of directors: the directors of the target remain bound to the company’s interest and are liable if they authorise guarantees or distributions that jeopardise solvency.

Ignoring these constraints is not a formal quibble: it exposes directors and acquirers to personal liability and can render the guarantees void.

Tax and structure

The deductibility of interest on the acquisition debt is one of the engines of the operation, but it must be verified: the tax authorities look closely at structures built solely to generate deductible interest without real substance (the theme of the “debt push-down” and thin capitalization, with the Swiss rules on hidden equity). The issuance stamp duty, the treatment of distributions and the 35% withholding tax on dividends must be modelled from the outset.

The mistakes to avoid

• Over-indebting the target: leverage that is too aggressive leaves zero margin for a bad year and turns a good deal into a crisis.
• Underestimating the bank covenants: complying with the financial ratios imposed by the banks conditions every future decision.
• Neglecting management: without a motivated team that stays, the cash flows that repay the debt vanish.
• Building unlawful guarantees: forcing the limits of company law to satisfy the bank is a risk, not a solution.

In summary

A well-executed LBO is a precise financial machine: the right target, sustainable leverage, a compliant corporate structure, optimised tax. The line between a brilliant acquisition and a collapse lies in the sizing of the debt and in respecting the legal limits that protect capital.

How we help you

The Capital division of SIH ONE structures LBO and management buyout operations: financial model, leverage sizing, acquisition vehicle and debt push-down compliance, directing the entire process together with banks, notary and auditor. Talk to the team.