An LBO is not one financing technique among others: it is a structure in which the company being bought pays for its own purchase. The principle fits in a sentence. Carrying it out does not: French law expressly forbids a company from financing the acquisition of its own shares, caps the deduction of interest, and polices the routes by which the target's cash travels up to the holding company. In practice it is these three constraints, rather than the financial model, that give the structure its final shape.
What an LBO is
How does a leveraged buy-out work?
An investor incorporates a holding company, has it borrow most of the price, and repays that debt out of the cash generated by the company acquired. The holding company, often called NewCo, has no business of its own: its only asset is the block of shares in the target, and its only resource is whatever the target pays up to it. The whole structure therefore comes down to a single legal question, one rarely framed in those terms while the price is being negotiated: by what route, and within what limits, may the target's cash lawfully reach the holding company to meet the instalments? The sections below answer that question point by point.
Where does the leverage come from?
From the fact that the return is measured on the equity committed, and that equity is only a fraction of the price paid. A worked example is clearer than a definition. A company is acquired for €30m, funded with €10m of equity and €20m of acquisition debt. Five years later it is sold for €36m with €8m of debt outstanding: the equity is then worth €28m against €10m invested, that is 2.8 times the money. Without debt, the same €30m invested for a €36m exit would have returned only 1.2 times. The difference comes from no additional performance by the business: it comes from the structure of the funding.
The symmetry is exact, and that is what gets forgotten. If the same company is sold for €24m with €14m of debt outstanding, the equity is worth €10m: the investment is recovered, no more. At a €20m exit, two thirds of it is lost. Leverage amplifies in both directions, and the more so the higher the debt. Which is why the level of gearing is not a question of comfort but a question of whether the structure survives.
The three levers, and what limits them
The financial lever
It works by substituting debt for equity, and its engine is deleveraging. Every euro repaid out of the target's cash flow mechanically turns debt into equity, with no growth required. This lever was historically the main one; it remains the most dependable, because it depends neither on the market nor on the cycle, only on the target's ability to generate cash. Its limit is rigidity: a debt instalment cannot be renegotiated to match a weak quarter.
The tax lever
It rests on interest being deductible at the holding-company level, and on dividends travelling up almost free of tax. Two regimes carry it: tax consolidation (FTC art. 223 A) and the parent-subsidiary regime (FTC art. 145 and 216). Neither is automatic: the first requires at least 95% of the target's share capital, the second a holding of at least 5% kept for two years. And since the ATAD directive was transposed, the deduction of net financial charges is capped (FTC art. 212 bis). The detail of these mechanisms, and of the two rules that cut them back, is set out in its own section below.
The operating lever
This is the only one that corresponds to real value creation: growth in operating profit during the holding period. It plays out through margin, revenue and bolt-on acquisitions made from the platform. On contemporary transactions it has become the dominant contributor to returns, precisely because the two previous levers have been pared back by tax and by the rising cost of debt. In legal terms it is expressed in the governance provisions of the shareholders' agreement: strategic committee, reserved matters, reporting, exit clauses.
The lever lawyers add
The legal lever: controlling the company with less capital than it appears. Preference shares carrying double voting rights or a priority dividend, a shareholders' agreement setting enhanced majorities, cross-options, tag-along and drag-along rights: the allocation of power does not have to follow the allocation of capital. This is the lever that lets a reinvesting manager stay in charge with a minority stake, and it is the one most often neglected during the negotiation, only to be regretted at exit.
The acquisition holding company
Why use a holding company rather than buy directly?
Because the debt must be carried by whoever receives the dividends, not by whoever pays them. If the buyer acquired the shares in its own name, the interest would be borne by an individual, with no deductible counterpart, while the target paid corporate tax on its profits before distributing. Interposing a company subject to corporate income tax places the interest charge at the same level as the dividend income, and allows both group regimes to apply there. That is the holding company's reason to exist: it is not a device, it is the only place where the charge and the income can meet.
What corporate form?
The société par actions simplifiée, in almost every case. The contractual freedom it allows means the management bodies, majorities, pre-emption, transfer, exclusion and exit provisions can all be drafted to measure, where the société anonyme imposes a rigid framework. It also allows preference shares calibrated for management. One point is sometimes discovered too late: the prohibition on a company financing the acquisition of its own shares applies to the SAS just as to the SA, through the cross-reference in article L. 227-1 of the Commercial Code. Contractual freedom does not reach that rule.
What the articles and the shareholders' agreement must cover from day one
The three moments at which the structure can seize up: a new shareholder arriving, a manager leaving, and the exit. In practice: pre-emption and approval rights, put and call options with price formulas distinguishing a good leaver from a bad leaver, tag-along rights for the minority, drag-along rights for the majority, and an agreed order of distribution of the exit proceeds. These clauses are negotiated while everyone still agrees. Drafted after the first disagreement, they are no longer drafted at all.
MBO, MBI, OBO, build-up: the variants
What separates the main structures?
The mechanism is identical; only the identity of the buyer changes, or the purpose of the acquisition. An MBO, management buy-out, is a purchase by the existing management team, usually alongside a fund. An MBI, management buy-in, is a purchase by incoming managers who take over. A BIMBO combines the two. A build-up, or leveraged build-up, uses a first acquisition as a platform from which to buy other companies in the same sector and assemble a group. A secondary buy-out is the sale of a company already under LBO to a new fund, with a fresh debt package.
The OBO: selling to yourself, and the tax trap that comes with it
An owner buy-out lets a founder sell shares to a holding company that the founder controls, turning part of the value into cash without leaving the business. The transaction is entirely lawful and common. It calls for two checks. First, the amendement Charasse (FTC art. 223 B): where the company acquired is bought from persons who control the group, a proportion of the group's financial charges is added back to taxable income, cancelling part of the tax lever. Second, the economic substance of the transaction: an owner buy-out whose only purpose is a tax advantage is exposed to the abuse-of-law procedure. The practical test is simple: the transaction must stand up on estate-planning or organisational grounds without the tax.
The layers of debt
Senior debt
The senior tranche ranks first, is the best secured and the cheapest; it is also the most demanding. Provided by a bank syndicate, it usually represents the largest share of the funding. It is classically split into an amortising tranche over five to seven years and a bullet tranche, sometimes with a dedicated acquisition line and a working-capital line alongside. In return for its ranking and its price, it carries the tightest set of financial ratios and of positive and negative undertakings.
Mezzanine debt
It sits between senior debt and equity, and is priced for that intermediate rank. Subordinated by an intercreditor agreement, it is repaid only once the senior debt is extinguished, usually as a bullet at eight or ten years. Its return combines cash interest, capitalised interest — PIK, payment in kind — and frequently access to equity through warrants. It extends the leverage without diluting shareholders further on day one.
Unitranche
A single instrument, subscribed by one private debt fund, merging the senior and subordinated layers. It has established itself on mid-market transactions because it removes the negotiation between creditors of different ranks, shortens the timetable and offers structuring flexibility that syndicated bank lending does not. It costs more than senior debt, and its documentation, drafted on Anglo-American lines, deserves close reading: the definitions do more work than the clauses. We have written separately on private debt, mezzanine and unitranche.
Vendor loans and bonds
The seller may remain a creditor for part of the price, and the holding company may issue debt securities. A vendor loan does two things at once: it reduces the external funding required and keeps the seller interested in a clean handover. It is almost always subordinated to the bank debt. A bond issue, for its part, opens the funding to non-bank subscribers; it then brings into play the rules specific to bondholders, which we cover in our analysis of bond issues.
How much debt?
Gearing is expressed as a multiple of EBITDA, and on mid-market transactions usually falls between three and six times. Beyond that, the rigidity of the debt service becomes the main source of fragility in itself: one weak year is enough for the leverage that multiplied the return to multiply the loss. At the structuring stage the right instinct is not to find the highest multiple the market will accept, but the multiple the company can carry in a downside case.
Covenants and what they trigger
What do the financial ratios actually measure?
Two figures, tested at each reporting date: gearing against earnings, and the ability to service interest. The first, the leverage ratio, compares net debt to EBITDA and steps down on a negotiated schedule. The second compares the same earnings to the cost of the debt. Alongside them sit undertakings that carry no figure: limits on capital expenditure, a ban on disposing of core assets, a ban on incurring new debt, strict control of distributions, and periodic information obligations. The package is completed by a cash sweep, applying surplus cash to early repayment.
What happens when a threshold is breached?
The lender acquires the right to accelerate, that is to demand immediate repayment in full. In practice acceleration is rarely declared straight away: it opens a negotiation, whose outcome is a temporary waiver, generally paid for, or an amendment rescheduling the debt. But the balance of power has shifted, and that is exactly what the clause is for. Hence the importance, on the borrower's side, of negotiating precise definitions at the outset, headroom on the thresholds, and an equity cure right.
Can a bank withdraw its facilities without notice?
Not for facilities of indefinite duration, which require written notice, subject to two exceptions. Article L. 313-12 of the Monetary and Financial Code requires the credit institution to notify its decision in writing and to observe a notice period fixed when the facility was granted. No notice is owed where the borrower has behaved in a seriously reprehensible manner, or where its position is irretrievably compromised. We return to this in our analysis of acquisition finance.
The prohibition on financial assistance
What exactly does the rule say?
A company may neither advance funds, nor make a loan, nor give security with a view to the acquisition of its own shares by a third party. The wording is in article L. 225-216 of the Commercial Code. It applies to the société anonyme, and to the société par actions simplifiée through the cross-reference in article L. 227-1. Applied to an LBO, it means the target cannot guarantee the debt raised to buy it, cannot pledge its assets in favour of the holding company's lenders, and cannot lend it the funds needed to repay that debt. This is the constraint that shapes the whole structure.
Why does the rule exist?
Because it protects the target's share capital and its creditors against a transaction that impoverishes them for nothing in return. In an LBO the interests of the holding company and of the target diverge on precisely this point: the first needs the second to secure its debt, the second gains nothing from doing so. The law comes down on the side of the target, its employees and its suppliers. The sanction is not theoretical: security given in breach of the text is void, and the directors who gave it incur liability, including, where appropriate, criminal liability for misuse of corporate assets (art. L. 241-3).
And in a limited liability company?
The prohibition is not written in the same terms there, but the exposure remains, by another route. The text addresses companies limited by shares. For the société à responsabilité limitée, the same result is reached through misuse of corporate assets: a manager who has the company secure the debt used to buy his own shares uses the company's assets contrary to its interest for personal ends. The absence of an express prohibition is not a permission.
Does a quick merger between the holding company and the target solve it?
It moves the problem, and it calls for the greatest care. Merging the holding company into the target after completion pushes the debt down to the operating level. The transaction is not forbidden in itself, but if it follows shortly after the acquisition and has no justification other than circumventing the prohibition, it is exposed to nullity as a fraud on the law, and the tax authorities may treat it as an abuse of law. A merger can be planned: it cannot be improvised in the weeks after completion, and it requires a documented economic rationale of its own.
The security that can actually be taken
What do the lenders secure themselves on, once the target is out of reach?
On what the holding company owns, which is essentially the target's shares. A pledge over the holding company's securities account, governed by article L. 211-20 of the Monetary and Financial Code, is the centrepiece: it covers the block of shares acquired and allows the creditor, on default, to have the shares appropriated or sold. It is completed by a pledge over the holding company's bank account, an assignment of the receivables it holds, and pledges over the shares of any intermediate holding companies.
What is asked of the managers
Measured personal undertakings, with particular attention to proportionality. Lenders frequently ask the reinvesting managers for a personal guarantee. A guarantee given by an individual is subject to a requirement of proportionality to that person's income and assets; if it was disproportionate when given, it may be reduced to what the guarantor could bear. We address this in our analyses of disproportionate guarantees and of the director's personal guarantee.
And the warranty and indemnity?
It does not secure the debt: it secures the truth of what was said about the target. The confusion is common. The warranty and indemnity, negotiated with the seller, covers liabilities arising, or assets disappearing, from causes pre-dating completion. It is measured in threshold, deductible, cap and duration, and is usually backed by security of its own — an escrow over part of the price or a bank guarantee payable on first demand. It protects the buyer, not the lender. See our page on warranty and indemnity.
What tax gives, and what it takes back
Tax consolidation
It allows the interest on the holding company's debt to be set against the target's profit. The regime in FTC art. 223 A lets a parent company become the sole taxpayer for corporate income tax across the group, provided it holds at least 95% of its subsidiaries' capital, directly or indirectly. This is what gives the tax lever its full effect: without it, the holding company would pile up losses it could not use while the target paid tax. The 95% threshold explains, on its own, the structuring of many transactions, and the attention paid to every last share left with a minority holder.
The parent-subsidiary regime
It allows the target's dividends to travel up to the holding company almost free of tax. FTC art. 145 and 216 exempt dividends received from a subsidiary held at 5% or more for two years, subject to a 5% add-back for costs and expenses. That add-back falls to 1% where both companies belong to the same tax consolidation group. Without this regime, each dividend would be taxed a second time on the way up, and the structure would lose most of its point.
The cap on interest deduction
Net financial charges are deductible only up to 30% of earnings before interest, tax, depreciation and amortisation, or €3m if that is higher. FTC art. 212 bis, which transposes the ATAD directive, replaced the earlier restriction rules with this general limit. It is assessed at the level of the tax consolidation group where there is one. In practice it caps the tax lever: beyond a certain level of debt, additional interest produces no further tax saving, and the real cost of the debt jumps.
The amendement Charasse
It neutralises the tax lever where you buy from yourself. FTC art. 223 B provides for the add-back of a proportion of the group's financial charges where the company acquired was bought from persons controlling the group, or from companies those persons control. The add-back runs over several financial years. This is the provision to examine first in any owner buy-out, and overlooking it costs exactly the saving you thought you were making.
Moving cash upstream without committing an abuse
Dividends
This is the ordinary route, and it requires distributable profit approved by the shareholders. The holding company cannot help itself: it receives what the target's general meeting decides to distribute, within the limit of the year's profit plus retained earnings and available reserves. Hence a timing problem that is routinely underestimated: debt instalments fall quarterly or half-yearly, distributions are annual. The gap is bridged by a working-capital line, or by a repayment schedule aligned on the rhythm of distributions.
Intra-group cash agreements
They allow advances between companies in the same group, by way of exception to the banking monopoly. A loan made by one company to another is in principle reserved to credit institutions; the exception for cash transactions between companies linked by capital conferring effective control makes the agreement lawful. It must still be in writing, provide for arm's-length remuneration, and serve the interest of each company concerned, not merely that of the holding company. The current account that results has its own regime, set out in our analysis of the shareholder current account.
Management fees
They are admissible only where they pay for a real service, distinct from the corporate office, at a proportionate price. Charging the target for management services already covered by the director's mandate exposes the agreement to nullity for want of consideration, the cost to disallowance as an abnormal act of management, and the director to misuse of corporate assets. The agreement must describe the services, the time spent and the pricing method; it will also, in most cases, fall within the related-party agreements procedure.
Corporate interest and abuse of majority
A distribution decided solely in the holding company's interest, at the expense of minority holders and of the target, can be set aside. Article 1833 of the Civil Code requires a company to be managed in its corporate interest. A distribution policy that drains the target's cash to meet a debt instalment, with no regard to its operating and investment needs, amounts to abuse of majority: the decision is contrary to the corporate interest and taken for the sole purpose of favouring the majority at the expense of the minority. The risk is real as soon as minority holders remain in the target — and it explains, once again, the search for 100% ownership.
The management package
What is it for?
To align managers with performance by giving them a share of the gain larger than their share of the capital. Managers reinvest part of their own money alongside the fund and receive, above an agreed return threshold, a share of the gain greater than their percentage holding. The instrument varies: ordinary shares, preference shares with a ratchet, warrants. The whole is held together by a shareholders' agreement and cross-options, with leaver provisions distinguishing those who leave well from those who leave badly.
How is it taxed?
FTC art. 163 bis H, introduced by the Finance Act for 2025, now sets the regime applicable to the gain. The question is decisive for the manager: it separates a capital gain from additional employment income, with a difference measured in tens of percentage points. We devote a full analysis to it: management packages, structuring, tax and leaver clauses.
When the leverage turns
Who fails first?
The holding company, because it has no business to absorb the shock. The target can get through a difficult year by cutting investment; the holding company has only one outgoing, the debt instalment, and one resource, the dividend. A suspended distribution translates immediately into suspension of payments one level up. That is why the treatment of a distressed LBO almost always begins with the holding company rather than with the business.
Which tools, and when?
The preventive procedures, for as long as suspension of payments is not established or is less than forty-five days old. Mandat ad hoc and conciliation allow the debt to be renegotiated confidentially under a third party appointed by the president of the court. Safeguard proceedings, opened before suspension of payments, impose a stay of proceedings and open the way to a plan. What matters is the calendar: the most effective tools are the earliest ones, and they close as soon as suspension of payments has set in. We set out this sequence in our analyses of mandat ad hoc and conciliation and of debt restructuring.
The director's own exposure
Continuing a loss-making business and commingling of assets are the two traps of a distressed structure. A director who lets the target fund the holding company beyond what the cash agreement permits is exposed to extension of the proceedings for commingling of assets, and to a claim for the shortfall of assets. We address these questions in our analysis of a director's personal exposure in insolvency proceedings.
The points that decide, in one table
What to check, and in what order?
The table below sets out the seven questions that determine the final shape of the structure, and the text that answers each. It does not replace a review of the file: every line calls for verification against the articles of association, the accounts and the finance documents. It serves to order the work, and to catch early the points that, dealt with late, force the structure to be rebuilt.
| Question | What decides it | Text or concept |
|---|---|---|
| Can the target secure the acquisition debt? | No, never, in a company limited by shares | Commercial Code art. L. 225-216 |
| What do the lenders secure themselves on? | The target's shares held by the holding company | Monetary and Financial Code art. L. 211-20 |
| Is the interest fully deductible? | No: 30% of EBITDA, or €3m | FTC art. 212 bis |
| Can the interest be set against the target's profit? | Yes, from 95% ownership | FTC art. 223 A |
| Do dividends travel up tax-free? | Almost: 5% add-back, 1% within a consolidated group | FTC arts. 145 and 216 |
| Does buying from yourself keep the tax lever? | No: part of the financial charges is added back | FTC art. 223 B |
| Can a distribution be challenged? | Yes, if it sacrifices corporate interest to instalments | Civil Code art. 1833, abuse of majority |
Common mistakes
“The target will guarantee the debt, that is market practice”
It is not market practice, it is a nullity. Security given by the target in favour of the debt used to buy it falls squarely within the prohibition on financial assistance. The mistake is all the more costly because it surfaces late, usually when the lender wants to enforce, which is the worst possible moment.
“There is 6% left with a minority holder, it does not matter”
That is exactly what loses tax consolidation. The 95% threshold is not an indicative target. Below it, the holding company bears its financial charges alone with no way of setting them against the target's profit, and a substantial part of the model evaporates. The remaining shares are bought before completion, not after.
“We will merge afterwards to push the debt down”
A merger decided in the wake of completion and with no rationale of its own reads as circumvention. It is exposed to nullity as a fraud on the law and to tax abuse of law. A merger is prepared, justified economically and documented; it is not presented as step two of an acquisition scheme.
“Management fees will cover the instalments”
They can only pay for a real service, distinct from the corporate office, at a proportionate price. Sized on the holding company's needs rather than on the service rendered, they are disallowed for tax and may amount to misuse of corporate assets. A holding company's cash requirement is not a pricing method.
“We will do the shareholders' agreement after completion”
After completion the balance of power has changed. Exit provisions, options and price formulas are negotiated while the parties still share an interest in signing. Deferred, they run into the first disagreement, and they are the ones regretted five years later, at the point of sale.
Frequently asked questions
What is an LBO, in one sentence?
It is the acquisition of a company by a holding company that funds most of the price with debt, repaid out of cash moved up from the company acquired. The investor commits only a fraction of the price as equity, which amplifies the return if the transaction succeeds, and the loss if it does not.
What is the difference between an LBO and an MBO?
LBO describes the mechanism of acquisition through leverage, whoever the buyer is. An MBO is one variant of it: the purchase is led by the existing management team, usually alongside an investment fund. An MBI is a purchase by incoming managers, and an OBO a purchase by the owner from himself.
Can the company acquired secure the debt used to buy it?
No. Article L. 225-216 of the French Commercial Code prohibits a company from advancing funds, making a loan or giving security with a view to the acquisition of its own shares by a third party. The rule applies to the société anonyme and to the société par actions simplifiée. In a société à responsabilité limitée the prohibition is not written in the same terms, but the same conduct amounts to misuse of corporate assets.
How much debt can an LBO carry?
On mid-market transactions, total leverage usually falls between three and six times EBITDA. The right test is not the highest multiple the market will accept, but the one the company can carry in a downside case: it is the rigidity of the debt service, not its size, that brings structures down.
Is the interest on acquisition debt deductible?
Partly. Net financial charges are deductible only up to 30% of earnings before interest, tax, depreciation and amortisation, or €3m if that is higher (French Tax Code art. 212 bis). Tax consolidation, which requires at least 95% ownership, additionally allows those charges to be set against the profit of the company acquired.
How long does an LBO last?
The usual holding period is five to seven years. That is the time needed to execute the value-creation plan, deleverage the holding company materially and prepare the exit, whether a trade sale, a sale to another fund or a listing.
What happens if a covenant is breached?
The lender acquires the right to accelerate and demand immediate repayment. In practice this opens a negotiation leading to a temporary waiver, generally paid for, or to an amendment rescheduling the debt. If the negotiation fails, the preventive procedures — mandat ad hoc, conciliation — are the tools to open without delay.
