Making an LBO work, by learning the signals.

• Author: Morris, Daniel M.
• Position: Leveraged buy-outs - Include related article on how to tell if an LBO is in trouble

Making an LBO work, by learning the signals

After a leveraged buyout, many executives find themselves sailing in uncharted waters. Preacquisition "operations-as-usual" plans do not track actual results, cash is tighter than projected, and the corporate vessels are just not as watertight as expected. Mayday calls to headquarters for short-term financing, legal assistance, and other help no longer are possible.

For the acquiring management to be successful in an LBO, it must learn to anticipate business changes in advance, adjust its management techniques to match new circumstances (without layers of staff support), act and react more quickly than its couterparts in large corporations, and consistently meet or exceed all projections. In short, the new management has to have and use all of the instincts of successful entrepreneurs. It has to achieve the same results, but operate without the same cash resources, if it wants to be successful.

An estimated 70 percent of LBOs will not achieve their original objectives. Of these companies, 50 percent will experience serious financial problems, including bankruptcy, divestiture, sale of assets, or other compromise.

In addition to managing heavy debt service, LBO companies must maintain unusually high performance standards to cover premiums paid to original owners and to satisfy investors for the high level of risk assumed. Moreover, occasional management mistakes have magnified consequences in their highly leveraged environments.

There is little, if any, margin for forecasting error in LBO companies. Refinancing success becomes a matter highly dependent on management credibility. And performance related to plan is a key consideration of lenders in assessing management strength--although once a plan doesn't jibe with the expected results, poor performance is assumed, as opposed to poor forecasts.

What are some of the main factors that determine the effectiveness of an LBO manager? Above all, his cash flow position, plan for the future, and establishment of good accounting controls.

A cash-flow orientation

Succeeding in a highly leveraged environment is based on managing for cash flow, coupled with a controlled risk-taking mentality.

More than any other shortcoming, LBO managers fail to "take home" the idea that cash is king. Any disbursement of cash for non-productive purposes causes expanding ripples throughout entire organizations. For instance, if the operations division of a company spends...