Crowdfunding becomes easier today with the US passing a law allowing small businesses to raise funds via crowdfunding.
Clinton (23 March 2012)
When it comes to buying websites, I think that given the current lending environment, doing a classic LBO with an e-commerce company is going to be extremely tough. In fact, even buying middle-market B&M companies in a classic LBO is nearly impossible, at least in the United States.
I recently handled an acquisition of an e-commerce business for a client. The purchase price was in the low 7 figures and, though it had some elements of an LBO (some bank financing and a seller note), it was really an extension of my client's current business. The bank line was already in place and collateralized not just with the purchased assets (which included some inventory and receivables but were mostly intangibles) but also the substantial assets of my client's existing business. The note was a fairly small percentage of the total purchase and was contingent on the business reaching certain projected gross sales, so the note was less of a financing tool and more of way to get the buyer and seller together on the price of the business.
I don't want to throw cold water on the idea of doing an LBO, but unless you have a seller who is extremely motivated to take a huge portion of the purchase price of the business in a note, you will have a hard time putting all of the necessary pieces together.
Is there a difference between an LBO and just applying for a loan through a bank or some other form like lending tree and approaching the seller with this lump sum of money? From my point of view it seems like it would be the financier of the borrowed money that would be hard to win over and not the seller since you are just presenting them with the borrowed cash amount?
Why does the seller care if the money is borrowed or not?
Here is an example of an LBO:
Purchase price $15 million
--Bank loan secured by company assets: $8.5 million
--Seller note: $3.5 million
--Management team: $600,000 for 20% of equity
--Buyer: $2.4 million for 80% of equity
In this example, the buyer is able to take control of a $15 million company for an investment of $2.4 million. In some cases, the buyer would also have to assist the members of the management team in coming up with their investment, although the $600,000 would generally be divided up among 5-7 individuals, so even the CEO at say 5% would only need to come up with $120K, perhaps from a combination of a home equity loan and borrowing from his 401(k) plan if he didn't have cash or investments he could liquidate.
The "leverage" comes in because if the value of the business increases to $18 million from $15 million, the buyer has doubled its investment. If the value goes to $21 million, he has tripled his investment.
If the buyer borrows a portion of its $2.4 million equity, it is further leveraged, but at least in my neck of the woods, that leverage is not, strictly speaking, a function of the LBO.
The seller walks away with $11.5 million of the purchase price at the closing but is still owed $3.5 million. The seller does care how much of the purchase price is borrowed because the loan has to be serviced or the seller note cannot be paid. In every transaction I worked on, the seller note was subordinated in payment and in collateral to the bank's loan.
The seller may also care if the buyer's $2.4 million is financed as well. The seller wants the buyer to have an incentive to increase the value of the business, so that the seller's note gets paid. If the buyer finances say 80% of its $2.4 million investment, the buyer now has only $480K at risk. If the business takes a downturn and requires additional capital to the tune of $1 million, a buyer with only a $480K investment may be more tempted to walk away from the company and let it fail while a buyer with $2.4M tied up in the business may be more likely to make the follow on investment.
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 (3 April 2012)
Domain Capital offers financing based on a domain name's value. I pay a note to them on a domain we've bought from someone who has financed its purchase through them.