When considering a Leveraged Buyout (LBO) operation, the choice of investment fund is crucial for the success of your project. Investment funds are not only sources of capital, but also strategic partners that can bring valuable expertise, resources, and networks. It is therefore essential to understand who these funds are, how to select them judiciously, and what criteria your company must meet to attract the best investors.

What is an LBO fund and how does it invest?

Investment funds can vary depending on their strategy, size, and objectives. Thus, we find several categories of funds including:

1. Venture capital funds: Invest in early-stage companies with high growth potential.
2. Growth equity funds: Focus on expanding businesses that require funds for further development.
3. LBO funds: Specialize in financing leveraged buyouts, providing both equity capital and transaction structuring.

LBO funds provide not only equity capital, but also sophisticated financial structuring to optimize return on investment. Among the best-known LBO funds are: KKR (Kohlberg Kravis Roberts & Co.), Carlyle Group, Blackstone, TPG Capital, Apollo Global Management, Eurazeo, etc.

These LBO funds can be classified into two main categories: specialized funds and generalist funds.

• Specialized Funds: These funds concentrate their investments in specific sectors, such as technology, healthcare, or financial services. Their sector expertise allows them to better understand market dynamics and bring significant added value to the companies in which they invest.
• Generalist Funds: These funds invest in a variety of sectors without specializing in a particular field. Their diversified strategy allows them to spread risks and seize investment opportunities across different market segments.

Investment obligations

LBO funds have significant amounts to invest, typically raised through investment vehicles such as private equity funds. These vehicles are funded by institutional investors, also known as LPs (Limited Partners), which include pension funds, insurance companies, and family offices. The funds have the necessity to invest the money entrusted to them by their LPs. It is therefore essential for them to successfully close deals in order to generate returns and meet the expectations of their investors.

However, to invest these amounts, LBO funds must meet numerous obligations including:

• fiduciary obligations towards their LPs. They must manage the funds in a prudent and transparent manner, aiming to maximize returns while minimizing risks. LPs expect regular reports on investment performance and clear communication on the fund's investment strategy.
• portfolio diversification obligations to limit risks. This means they cannot invest too large a proportion of their funds in a single company or sector. This diversification is crucial to minimize potential losses and maximize overall returns.

The main objective of LBO funds is to generate high returns for their investors by increasing the value of acquired companies. This is achieved through operational improvements, organic growth or through acquisitions, and rigorous financial management. In order to act on these levers, LBO funds select their investments based on strict criteria that guarantee them a high return.

Investment Criteria of LBO Funds

When an investment fund receives a teaser for an LBO operation, several criteria are taken into account to decide on the opportunity to invest:

1. Majority or minority position: Funds must determine whether they prefer to take a majority position, involving significant control over the company, or a minority position, allowing them to provide support without controlling the company. Some funds only invest in majority positions, others only in minority positions, while some can do both. Choosing a majority position allows the fund to more directly control the strategic and operational decisions of the company, which can be crucial for funds seeking to implement significant and rapid changes. On the other hand, a minority position limits the fund's control, but often allows investment in larger companies where smaller investment tickets are needed.
2. Ticket size: The size of the required investment must be in line with the fund's financial capacity and strategy. Each fund has minimum and maximum investment thresholds it is willing to commit. The ticket size is of paramount importance: a too modest ticket risks not attracting large-scale funds seeking substantial investments, while a too high ticket may exclude smaller funds or those specializing in minority investments.
3. Business sector: Funds specialized in certain sectors will closely examine the relevance of the target company's industry in relation to their sector expertise. For generalist funds, the investment team's expertise in the sector can also play a crucial role. Their performance history, that is, whether they have obtained good returns on past operations, is also a determining factor. Moreover, there may be sector trends influencing investment decisions. For example, there have been numerous investments in veterinary clinics in recent years,
4. Geography: The geographical location of the target company can be crucial. Some funds focus on specific regions where they have local knowledge and resources. Additionally, there may be regulatory obligations on investment zones, which can influence the decision of certain funds to focus on or avoid certain regions.
5. Portfolio diversification: Funds seek to diversify their investments to manage risks. Investing in companies from different sectors and regions helps mitigate the negative impacts of market volatility.
6. Profitability: The current and future profitability of the target company is a determining factor. Funds evaluate financial projections to ensure that the investment will generate adequate returns.
7. Experience and expertise: The fund's ability to generate significant added value for the target company through its experience and expertise in similar operations. It is imperative for a fund to maximize the profitability of its investment. To this end, it must not only help the company increase its profit margins, but also stimulate the growth of its revenue.
8. Bandwidth: The resources available within the fund, particularly in terms of time and attention that partners can devote to each investment, are crucial. A fund may decide not to engage in a new operation if it does not have sufficient bandwidth to effectively manage the investment.
9. Exit strategy: A clear understanding of the available exit options and the likely timing to realize the investment is essential. Funds must ensure they can achieve returns within an acceptable timeframe.
10. Alignment of values and objectives: It is important that the values and strategic objectives of the target company are aligned with those of the fund. This includes cultural and ethical aspects, as well as growth and development ambitions. Moreover, ESG (Environmental, Social, and Governance) criteria are now part of the funds' investment criteria, reflecting a growing concern for sustainability and social responsibility

By evaluating these criteria, investment funds can make informed decisions about the opportunity to invest in a company, thus ensuring that the LBO operation is aligned with their financial and strategic objectives.

Return objectives and target selection criteria

LBO funds typically have a defined investment period, often 5 to 7 years. During this time, their main objective is to maximize the value of the acquired company. This is achieved through operational improvements, strategic expansion, complementary acquisitions, and rigorous financial management. The funds realize their returns by selling the company at a price higher than the initial purchase, often through a sale to another investor, an initial public offering (IPO), or a sale to the company's management. The return on investment objectives are very high, around 20% - 25% IRR, which explains the rigorous selection of their targets.

Thus, to maximize returns, LBO funds look for companies that meet specific criteria. Among the typical characteristics of a target for an LBO operation, we find:

• Stable results and cash flows: Sufficient profits to finance the structure and absorb the cost of financing.
• Solid financial structure: Largely consisting of equity and with low investment needs.
• Stable business sector: Mature company operating in a sector without significant economic fluctuations.
• Healthy financial situation: Significant profitability, reasonable and controlled debt, business that is not capital-intensive.
• Cash flow forecasts: Surplus, recurring, and predictable cash flows.
• Quality management: Competent management team.
• Growth potential: Clear strategy with opportunities for internal and external growth.
• Competitive advantages: Strong market position, suitable production tools, and limited environmental threats.
• Transferable know-how: The seller should not be too critically involved ("key person").

Understanding the investment duration of funds, the mechanisms for generating returns, and their key selection criteria is crucial for grasping the investment strategy of LBO funds and their expectations regarding the companies in which they invest. But if the criteria for funds are high, they must also be high for their investment target. Selecting the right fund for long-term support is essential, and many success stories would not have been possible without the right partner.

What criteria for selecting a fund?

When choosing a fund for an LBO operation, several criteria should be taken into account. Here are the main ones:

1. Experience and expertise: Ideally, the fund should have significant experience in executing LBO operations and an in-depth knowledge of the target company's industry sector. Depending on the company's project, whether it involves international expansion, mergers and acquisitions (M&A) operations, or other strategic initiatives, it is crucial to consider the fund's expertise in supporting these key areas. Some funds have significant experience in these domains and can offer valuable support and specialized advice to maximize the company's chances of success.
2. Track record: The fund's past performance in terms of returns obtained on investments made is a key indicator. A good track record inspires confidence.
3. Financing capacity: The fund must have the necessary financial resources to support the operation, including the ability to raise additional funds if needed. This additional financing capacity can be more or less strategic depending on the company's project. If it seeks to carry out numerous build-ups requiring reinvestments, it is wise to choose a fund with the capacity to reinvest.
4. Network and relationships: A well-connected fund can bring additional opportunities, strategic partnerships, and facilitate access to complementary sources of financing. For example, the Eurazeo fund has often been recognized for its ability to bring strategic relationships and growth opportunities to its partner companies thanks to its vast international network.
5. Alignment of interests: It is crucial that the fund's objectives are aligned with those of the target company's management. This includes clear expectations in terms of returns and investment duration.
6. Operational support: Some funds offer operational and strategic support, which can be an advantage for improving the company's performance post-acquisition. For example, KKR has an internal team specialized in operational improvement that collaborates with companies to optimize their internal processes and reduce costs. Similarly, Blackstone offers a digital transformation program to help companies adopt new technologies and improve their operational efficiency.
7. Investment conditions: The terms and conditions proposed by the fund, including the structure of the agreement, exit mechanisms, and governance rights, must be favorable and clearly defined.

New LBO operations with the entry of new funds are often an opportunity for the company to access another form of support on topics related to its growth. This also allows, if necessary, to move to larger funds with additional financing capabilities. These funds can help the company take its development projects to another level by providing additional resources and skills to support more ambitious expansion.

How many funds should be invited to an M&A process?

The number of funds to invite in an LBO process can vary and requires careful consideration to be carried out with your M&A advisors. Here are some key insights on this topic.

Phase I

A very open process in Phase I presents both advantages and disadvantages. The advantages include a greater diversity of proposals and approaches, which helps to maximize the chances of obtaining a large number of Letters of Intent (LOIs). Such diversity can increase competition among funds, potentially leading to more attractive LOIs.

However, some funds may be discouraged from participating if they feel their chances of success are minimal, which could reduce the quality of offers received. By soliciting too many participants, the signal sent can also be negative and perceived as a sign of weakness of the company. Moreover, if you choose a dual track process (funds and strategic buyers), some funds may be reluctant to participate, fearing that a strategic buyer might be willing to offer a higher price. This uncertainty can lead them to hesitate in investing significant resources in the process.

It is therefore crucial to find a balance between the openness of the process and managing the expectations of the funds. A well-thought-out approach will maximize the chances of success and allow for obtaining the best investment conditions.

Phase II

For phase 2, it is generally recommended to reduce the number of funds to three. This strategy allows for maintaining sufficient competition while avoiding overburdening management with too many requests. By limiting the number of funds, each participant has a better chance of winning the process, which encourages them to invest time and resources more committedly. Additionally, this simplifies the management of the process and allows management to focus on the most promising offers. It is crucial not to neglect the commitment required from management during the due diligence phase.

That being said, this approach should be nuanced based on the quality and number of offers received. For example, in the case where only one offer seems relevant and solid, it may be wise to consider granting exclusivity to a fund. This measure would allow for reducing timelines and simplifying the process. However, it is crucial to proceed intelligently so that the fund does not perceive this exclusivity as a sign of weakness from the company. Funds often seek to obtain exclusivity to reduce their costs and increase their chances of success, which constitutes a significant advantage for them. However, if they realize that they are the only ones in the running and that the company is having difficulties finding investors, they could take advantage of this to propose less favorable terms.

Finding a subtle balance is essential, and the best M&A banks can help you navigate this complexity to maximize your chances of success while obtaining the best possible terms. Moreover, maintaining a tight timeline and a certain competitive pressure is essential in an LBO process. This allows for keeping funds engaged and maximizing the terms of the agreement. Rigorous management of the schedule can also help obtain more favorable offers.

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In summary, the success of an LBO operation relies on a careful selection of investment funds, a clear understanding of the obligations and responsibilities of each actor, and a rigorous evaluation of investment criteria. By taking into account experience, expertise, financing capacity, and alignment of objectives, companies can maximize their chances of success. The management of a structured and well-orchestrated process is also crucial to attract the best partners and obtain optimal investment conditions. Ultimately, choosing the right fund and implementing a well-defined investment strategy are essential for achieving high returns and ensuring the growth and longevity of the company.