Consider a leveraged buyout as a faster, easier way to own a company

The vogue in today’s business world is to start a business, and you may hear how an idea was fostered out of a garage. The chances that a bank will support such a venture are zero. The chances you will find a venture capitalist interested in funding a garage startup are slight. You really must hope to find an investment angel – your only real choice. Sure there are exceptions, but you are looking for a needle in a haystack.

Instead, let me make the case for a leveraged buyout. I maintain the road to riches is easier and much faster via the leveraged buyout route, especially if you are talented and still have little money. Here’s how it works.

The scenario

First, you must find an asset-rich business, preferably a business run by a second or third generation. In many cases, the company is no longer run by the founding entrepreneur, and is in a harvesting or maintenance mode. In other words, the company is just bouncing along with little injection of new ideas, innovation or capital.

Secondly, you must determine the approximate price the seller is asking for the business. Let’s say $5 million. The company’s value is usually determined by a multiple of earnings. A slow growth or zero growth company will usually sell at a low multiple, and a growth company will sell at a higher multiple.

Beauty is in the eye of the beholder. The ideal company for a leveraged buyout is to find a no-growth company that you can turn into a growth company. That is what we did with Invacare Corporation and Royal Appliance Manufacturing Co. (manufacturer of the “Dirt Devil” vacuum cleaner).

In both cases, we made millions of dollars for investors.

Back to the $5 million company. Next, go to a banker and determine how much the bank will lend on the assets. They will usually lend 85 percent on receivables, 50 percent on inventory and 50 percent on the quick sale value of plant equipment.

Getting a loan

Let’s assume the bank will loan you $3 million. Now you need $2 million and then you will own a company. Maybe the plant is worth $1 million, so you sell the plant and lease it back.

One million dollars to go. Maybe you can talk the seller into holding a note for part of the purchase price. Say $750,000. Now you only have to raise $250,000 in equity to buy a $5 million company. But you don’t have any money.

Usually the jockey, or the person who will run the company, gets what is called a “carry,” which can vary from 10 to 20 percent of the company for free for putting the deal together. All you need to do is sell the bank that you are worthy of getting the required loan and convincing investors that you are worth investing their $250,000. If you have any money at all, invest in yourself.

I am always more interested in what percentage of your liquid net worth you are putting in the deal more than the absolute amount. All you need to do is to sell the bank and investors on you and your plan.