LBO for website acquisition

Alasdair, under the capital structure irrelevance principle, the return of a business isn't affected by how that business is financed ...whether that's via equity or debt. The weighted average cost of capital is a constant.

Take two examples of identical companies with exactly the same turnover and profit. One is a leveraged firm, L (has $1000 debt), and the other is an unleveraged firm U (no debt). You could buy the assets of L for $1000, but to buy the assets of U, you have to pay $1000 plus you'll have to pay extra - another $1000 - equivalent to the extent of L's leverage (the company with same profit but the advantage of no debt will cost you more money).

Both companies make $300 a year. With L you have to pay half of that to the banks in interest. With U you get to keep the full $300.

Your return if you bought L at $1000 and got half of $300 = 15%. Your return if you bought U for $2000 and got to keep all of $300 = 15%.

Bear in mind that it's the buyer who'll be servicing the debt and he'll be servicing it out of future income. His income. Whether he paid for the company out of his savings or out of money he's borrowing should be irrelevant to you, the seller. If he's securing that debt with his house or with the assets in the business he just purchased should be just as irrelevant to you. What if he paid with his own money and then used the assets of the business as collateral to release capital? Would you be ok with that?

If you're interested in the financial theorum behind this, check out Modigliani and Miller. This is a good explanation of the theorum.