The End of LBOs?

Investors acquire a target company through an acquisition holding company, created specifically for the occasion, which takes on debt up to the maximum level allowed by the target's cash flow generation. This holding company is capitalized only to the extent of the remaining purchase price (financial leverage). The acquisition debt is subsequently serviced by the parent company's cash flow, derived primarily from dividends and management fees paid by the target entity. (*)

The LBO technique is frequently subject to criticism. During the 1980s, certain undervalued groups were acquired, dismantled, and sold off piece by piece by corporate raiders utilizing leveraged buyouts. More recently, François Hollande—in the midst of his presidential campaign—pledged to reform or even outright eliminate the LBO mechanism through legislation. Speaking to workers at the Still-Saxby plant in Oise who were facing potential offshoring, he denounced "financiers who strip the substance from a company."

These criticisms stem from past excesses. To push a target company toward maximum short-term profitability, some sponsors slash operational expenses and curtail capital expenditures. Rather than building up the business, they deplete its resources in pursuit of rapid financial returns. To structure highly leveraged transactions (HLTs), certain LBO funds specialized in identifying ideal targets featuring:

• Low working capital requirements (WCR)

• Substantial cost-cutting potential

• Strong, established market position

• Abundant fixed assets (serving as collateral for lending banks)

Management teams are given equity participation tied to performance metrics to ensure alignment and commitment. However, burdened by high debt service obligations, these companies become far more vulnerable to market downturns or macroeconomic shocks.

So, should the LBO mechanism be brought to an end?

It is important to note first that the LBO technique extends far beyond the negative archetype—which, while real, remains marginal—described above. Virtually all acquisitions of small and medium-sized family enterprises rely on bank financing, quite simply because the buyer does not possess the full amount of liquid funds required for the purchase. A abrupt ban on this financing mechanism would severely disrupt the continuity of SMEs, many of which are actively seeking buyers.

In our market, leverage ratios for SMEs remain conservative, particularly following the financial crisis. By capping debt at 3 to 4 times EBITDA (the company's gross operating profitability) and requiring an equity contribution of 25% to 40% of the agreed transaction value, banks establish healthy safeguards designed to absorb unforeseen events.

Our legal framework also curbs structural abuses. In Belgium, a company cannot incur debt or pledge its assets for the financial benefit of its parent company, except (since 2009) under extremely strict statutory conditions and subject to the criminal liability of its directors (former Art. 629 of the Companies Code).

The root of credit (from the Latin credere: to trust) is confidence between the lender and the borrower. It is a fundamental mechanism for economic growth, enabling entrepreneurs to bring their business projects to fruition. Excess is harmful in any domain, and LBOs must indeed be regulated to prevent speculative abuses. However, eliminating a financing tool that is essential to the survival and transferability of our SMEs would prove deeply damaging.