The leveraged buyout post covered the main engine: buy with borrowed money, let the company service the debt, sell in about five years. But the model has a toolkit beyond the engine, a set of standard instruments by which cash moves from the acquired company to its owners between purchase and exit, and sellers evaluating a leveraged buyer deserve the full inventory. Every tool here is legal, disclosed in the fine print of the deals that use it, and defensible in the right context. The point of the tour is neither outrage nor reassurance. It’s fluency: your company may be the object of these mechanics someday, so you should be able to read them at sight.
Management and monitoring fees
Many sponsors charge their portfolio companies an annual fee (commonly 1% to 2% of EBITDA or revenue, structures vary) for oversight and advisory services, paid by the company to the fund’s management company, sometimes with additional one-time fees attached to the original transaction or later acquisitions. The stated logic: the sponsor provides real services (finance discipline, vendor pricing power, M&A execution), and portfolio companies pay for them the way they’d pay any advisor.
What a seller should understand: the fee sits inside the company’s cost structure, ahead of the profit your earnout or rollover equity may be measured on, which makes one diligence question essential if you’re keeping any economic interest: is the fee added back for purposes of calculating my earnout and my equity’s performance? An earnout measured on EBITDA after a new 2% fee is an earnout that got quietly repriced. Get the definitions into the agreement, with arithmetic.
Dividend recapitalizations
A dividend recap is refinancing your house to take cash out, performed on a company: the business borrows additional debt, and the proceeds are distributed to the owners (the fund) as a dividend. It lets a sponsor return money to investors before selling the company, sometimes recovering their entire original equity within a couple of years, and it’s a routine tool in sponsor-owned companies during friendly credit markets.
The economics worth seeing plainly: after a recap, the sponsor’s remaining risk in the company can approach zero while the company’s debt load has grown, meaning the downside of any future stumble has been shifted toward the company itself: its lenders, and operationally, the employees and clients who live inside its now-thinner margins. A company can carry more debt in year four than it did the day it was bought. For a seller with rollover equity, a recap can also be good news (sometimes you participate in the distribution), which is exactly why the governance details matter: whether you share in recaps, and whether you have any say, is written in the equity documents, not in anyone’s intentions. (Rollover equity gets its own full post later this series.)
Sale-leasebacks and asset stripping’s polite cousins
If the company owns real assets (a building, a fleet, sometimes even contracts), those can be converted to cash: sell the building to a real-estate investor and lease it back, monetizing the asset while the company keeps using it, now with a rent obligation where an asset used to be. In moderation this is ordinary corporate finance; plenty of well-run companies prefer not to own real estate. The version to understand is the cumulative one: a company that has been recapped, fee-loaded, and sale-leasebacked is a company whose fixed obligations have grown at every step, and fixed obligations are what turn a soft year into a crisis. The 2am version of this story has famous retail-chain names attached to it; the daylight version happens quietly in small companies every year.
Who absorbs the risk
Run the toolkit end to end and a pattern emerges that no single tool shows: each instrument moves cash toward the equity holders earlier and moves risk toward the company’s own balance sheet, and the residual holders of that risk are the people who can’t diversify away from it: employees whose jobs ride on the margin, clients whose service rides on the staffing, and any seller still holding paper (notes, earnouts, rollover) junior to the debt. Lenders price their slice of the risk professionally. The others mostly inherit theirs without a term sheet.
That’s not an argument that leveraged buyers are the wrong choice. Sometimes they’re the right one, and the sellers who do well with them are the ones who saw the machinery clearly and negotiated accordingly. So, the questions, to put to any buyer whose structure includes leverage, and to us or any other operator too, because answers are cheap to collect and expensive to skip:
- Will the company pay ongoing fees to you or an affiliate after close? Are they excluded from my earnout math?
- What’s your history with dividend recaps in this platform? Would my rollover equity participate?
- Does the plan involve monetizing any of the company’s assets after close?
- What will the company’s total fixed obligations (debt service, fees, rent) look like against its EBITDA a year after close?
- May I see how the last deal you closed actually performed against what its seller was told?
Our own answers live where they should: in writing, deal by deal, with the funding of every offer explained before anyone signs. Hold everyone to that standard and the toolkit holds no surprises, which is all this post was for.