Harold Aucoin CPA Inc.

A leveraged buy-out:
A leverage buyout exist when you are buying assets (target) and using the target (the assets themselves) as collateral for the loan that you will use to buy the assets (kind of curcular reasoning; isn't it). There are likely endless variations of how to buy an asset and at least partially using the asset itself as collateral for a loan, borrowed from a local bank or credit union. I will concentrate on one scenario.

You want to buy a company. This means you need to buy the shares, and hopefully any outstanding notes (usually shareholder notes). If asked to mortgage the property owned by the target company, the bank or credit union will issue the cheque to the target company. That will go straight to the target company’s bank account. That’s because the property belongs to the target company. This is normal, and it is the essential problem. The buying shareholder must extract the funds borrowed to pay for the shares purchased. The shares are not the property of the target company. They are the property of the individual shareholder(s). The shares are owned by the seller who can be an individual or a “holding company”. Funds extracted from the “target” company are taxable in the hands of the buying shareholder. This means that the buyer has to pay taxes on the proceeds that is to be used to buy the target shares. That’s a big problem.

So what is the solution? The mechanics can be as follows (other procedures are possible): The shares are purchased by a holding company in exchange for a promissory note (a promissory note is merely evidence of debt-not the debt itself) to the seller. The assets of the target company are given as collateral to a bank. Both the company purchased and the buying company (holding company) are amalgamated into a single company. The bank issues its check to the amalgamated company. The amalgamated company issues a cheque to the individual seller in satisfaction of the promissory note. You now have both the asset (target) and the loan in the same company. You can claim the interest against profits of the amalgamated company.