Leveraged Buy-Outs (LBO): The challenge of financial assistance
In the world of corporate acquisitions, one of the most common yet complex structures is the LBO (leveraged buy-outs).
This is a mechanism whereby an investor – typically a private equity fund or a corporate group – acquires a company primarily through external financing. What is characteristic of this model is that the purchaser usually sets up a special purpose vehicle (Newco) to carry out the acquisition, and the financing is secured against the assets or future cash flows of the target company. In other words, the company is bought using its own resources or the profits it is expected to generate as collateral.
Thus, in a leveraged buy-out, the buyer contributes little of their own capital to complete the purchase and relies on the profits of the acquired company to repay the debt and generate a return on investment.
However, precisely because the repayment of the financing depends on the acquired company itself, a significant legal issue arises: the prohibition of financial assistance under the Spanish Companies Act (LSC).
The prohibition of financial assistance in leveraged buy-outs
The LSC contains a clear rule (Article 143.2 for limited liability companies and Article 150 for public limited companies): a company may not finance the acquisition of its own shares or equity interests. In other words, the company being acquired cannot assist the purchaser in paying for itself.
The purpose of this prohibition is to protect the company’s capital and safeguard the interests of both shareholders and creditors. If a company helps to finance the purchase of its own shares, its assets are being used to the detriment of existing shareholders and creditors.
Moreover, the prohibition is not limited to direct loans. It also extends to indirect forms of assistance, such as guarantees, sureties, or arrangements which, in practice, facilitate the acquisition.
That said, the law allows for certain exceptions: for example, transactions designed to enable employees to acquire shares, or those carried out by credit institutions in the ordinary course of their business.
The impact of the prohibition on leveraged buy-outs
A properly structured leveraged buy-out is perfectly feasible in Spain, provided that the financing comes from an external source – such as a bank or investment fund – and the debt is repaid out of the profits of the acquired company.
The risk arises when the target company itself (or any of its subsidiaries) participates in the financing: by lending money to the purchaser, securing the debt with its own assets, or assuming obligations related to the purchase price. In such cases, the courts have declared those clauses void for breaching the prohibition on financial assistance.
A relevant example is Supreme Court Judgment (STS) 582/2023 of 20 April 2023, where the Court annulled an agreement guaranteeing the purchaser against any loss in value of their investment, as in reality it was the company that bore the risk of the transaction — thus constituting prohibited financial assistance. Likewise, STS 541/2018 of 1 October 2018 clarified that when the purchase of shares is financed through mechanisms that infringe the financial assistance prohibition, it is the financing arrangement that is void, not necessarily the sale and purchase agreement itself.
Merger following a leveraged buy-out
In many leveraged buy-outs, the purchaser and the acquired company subsequently merge. Previously, Article 35 of the Law on Structural Modifications required the experts’ report on the merger to expressly indicate whether financial assistance existed.
Following the reform introduced by Royal Decree-Law 5/2023, the current Article 42 has removed that requirement. Experts are now only required to comment on the reasonableness of the transaction, without directly assessing whether financial assistance is present. With this amendment, the legislator appears to consider that the merger procedure — which already includes safeguards for shareholders and creditors — provides sufficient protection without the need for duplicated controls.
Conclusions
A leveraged buy-out is a useful mechanism for acquiring companies with a lower capital outlay, but it carries a clear legal risk. Therefore, a sound structure can make the difference between a successful deal and litigation over nullity.
Engaging a law firm specialising in M&A and Corporate Law, such as Devesa, is essential to ensure legal certainty in this type of transaction and to minimise the legal risks that could jeopardise the investment.
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