LBO for website acquisition

[thecheechee]

Hey everyone,

long-time lurker here...first time poster.

Anyways, in the most recent months I have begun to think about purchasing websites particularly those in the e-commerce space and have been doing some preliminary research.

As many of you entrepreneurs out there know, a lot of microcap companies are purchased using LBO (leveraged buyout) techniques usually with a combination of seller paper and bank financing. Has anyone tried doing this when purchasing a website? Is this even possible given the current lender squeeze and loan criterias? I ask because alot of websites out there, like drop-shipping sites aren't holding inventory so there aren't much "real assets" to borrow against. Can you finance against a domain name or future cash flows for an acquisition?

I appreciate anyone who can point me in the right direction on these issues...or anyone who wants to open a candid discussion on the topic.


Best,

TheChee

[Thomas]

What sort of price range you talking?

Financing is quite uncommon in the mid-range of the market but it does happen. It's almost always seller financing, though, I've not come across any where a bank has been lending against a site in the <$500k range.

[akirk]

I would guess that the biggest potential issue with LBOs in the internet world will be lack of physical assets - though an eCommerce site with physical stock could avoid that issue...
LBOs always strike me as a little bit strange:
"hello, we would like to buy your business, but we aren't going to put our own cash in, we are going to get your company to borrow (which you could do and keep the equity) and then we will look to walk away as soon as we can preferably flipping the company to someone who has real cash for more money..."
mmm

Alasdair

[MTUser]

From my experience, a lot of smaller websites will be available when the seller has a financial problems or when the seller has moved on to other things. In both these cases, the seller's tend to want all the cash now, and it has to be your cash not theirs.

[Clinton]

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 L for $1000, but to buy 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.

[akirk]

Thanks Clinton - good explanation...
perhaps I am old fashioned - but the mere concept of someone buying a business when they can't actually afford it themselves grates as a concept...
it encourages businesses into debt - and while usually profitable for the buyer - it is not always good for the business...
in essence:
- leveraged buyout
- company raises debt against assets
- purchaser looks to extract maximum cash value from the business / from a sale
- company left weaker / in debt
- staff affected as the standard practice is job losses

the principle aim of an LBO is to take a successful company / strip out any value / cut costs agressively (short-term with no regard to long term) - increase yearly profits - sell the shell on for more than paid, which retaining the assets...

yes, I understand that raising debt against assets can be a good thing - but generally a leveraged buyout is used in the VC world as a form of asset stripping and putting the risk onto the business - not caring if it long term weakens / affects the business which may be supporting a numer of livelihoods...

it is also a big part of the financial bubble which has caused so many issues - multiples of debt to ebitda (European) for LBOs are up by 50% since 2003 - was the multiple too conservative in 2003, or are folks getting greedier now?
when Permira and CVC bought the AA in an LBO in 2004 - the direct result was job losses / asset stripping (all following on from the Centrica purchase in the 90s) and I believe the AA was flipped again later on through a partial deal including SAGA...

If anyone believes that a lot of the financial issues now affecting the 'normal person' are down to those whose greed is setting the pace in the financial markets - then LBOs are a big part of that - they are structured around exploitation of firms for the benefit of the few... in principle that seems fine as a firm with assets in being asset-stripped hurts no-one - but unfortunately it does as it affects so many jobs across the country - sorry, I am not keen on them...
If someone wants to buy a company of mine it is cash please

Alasdair

[mikeb]

Alistair - I cannot agree as a principle, that buying business should not use borrowed money.

Sure - the credit bubbles were caused by using derivatives to over leverage capital, the main issue here is the traders responsible were never gambling own capital at all, and that is what was wrong with the banking system. They take a percentage of capital flow, so many could not care less the legitimacy of the assets traded, all they want is to increase capital flow. Also that there were no constraints placed on the leverage or options allowed of an underlying instrument which way exceed the underlying asset value.

Taken to its logical conclusion your thought is houses should not be bought with a mortgage, only cash. Clearly untenable.

A business purchase is different.

With any business what matters is return on capital and risk. Using loan finance is a sensible way to increase return on capital provided that sufficient capital is injected to cover increased trading levels, and likely asset valuation risk. If the traffic on a site has been stable for 2 years and income only variable by 20% over that period, then using 50% borrowed money even is a justifiable risk. It is also sensible to keep capital in reserve, because banks do not like people going back for more for the same asset!!

It all comes down to gearing

[Clinton]

I agree with you about why LBOs are not good for staff etc.

But it would be foolish of you to stand on principle and take a substantially lower price for your business from a cash buyer .... as there's no way you can contractually impose on him restrictions in relation to the company's future capital structure nor can you ban him from securing future borrowing against assets he owns. LBOs don't need to ring the doorbell, they've got a key to the rear entrance.

[akirk]

perhaps...
but - with any purchaser I would want to know the source of funding (I am going through this with a B&M business of mine at the moment) - I would also be looking at whether my assets had any value in part of the thinking...
of course I appreciate that this is different between a small business I own and large PLCs - and I guess that where a LBO can push money into the hands of shareholders, it might be more challenging for the business to strip their own assets into debt to push money to the shareholders as an alternative - so i can see why shareholders might vote for it... as happened with the AA / RAC / etc.

I just see it as unethical business - business is of course about making money - but not at any costs...

personal view though

Alasdair

[Thomas]

This thread has gone a little off track.

Weren't we talking about financing website purchases rather than arguing the merits of a LBO?

The discussion has got very complex, seeing as the OP is probably talking about sites under the $500k range, where cash offers are common and there are usually little/no assets to secure financing against. No-one wants complex buyout terms on a small business. In all the deals I have completed, the worst are where the buyer comes from the corporate world and starts trying to apply the same concepts to a small business. It gets extremely messy and extremely complicated very quickly.

Anyone have any other creative ways to finance a buy out (of a web business!)?