LBO & SPV

In the corporate finance ecosystem, private equity occupies a singular position. It is not simply “investment capital”: it is a well-oiled machine of acquisition, transformation and divestment that has driven some of the most significant transactions in both the Spanish and international markets. Understanding how it works —and the role that leveraged buyouts (LBOs) and special purpose vehicles (SPVs) play within that machine— is essential for financial advisers and business owners alike when considering a corporate transaction.

This article examines the fundamentals of private equity, describes the real mechanics of an LBO, explains the structural function of SPVs, and addresses the legal and tax considerations that govern these structures in Spain. Understanding the logic of the financial buyer is, for any owner contemplating a sale, a genuine negotiating advantage.

What is Private Equity?

Private equity encompasses investment funds that raise capital from institutional investors —pension funds, insurance companies, family offices, high-net-worth individuals— with the objective of deploying it into companies that are not publicly listed. Unlike a stock market investor operating with relative liquidity, a private equity fund acquires a significant or controlling stake in a company, works actively to transform it over a defined period and, at the end of that horizon, executes its exit, maximising returns for its investors.

The typical investment horizon ranges from three to seven years. During that period, the fund is not a passive shareholder: it intervenes in management, imposes financial discipline, drives organic and inorganic growth, and professionalises structures that in many family-owned or mid-sized businesses have operated informally for decades.

Private equity in Spain has reached a notable level of maturity in the mid-market segment —companies with EBITDA of between €3 million and €30 million. Funds specialising in this segment seek businesses with a defensible competitive position, predictable cash flows and meaningful operational improvement potential. The ideal LBO candidate is not necessarily the largest or the most glamorous company: it is the one that generates cash consistently.

LBOs: The Mechanics of a Leveraged Buyout

The leveraged buyout (LBO) is the acquisition technique most characteristic of private equity. Its logic is straightforward in concept, though complex in execution: the fund acquires a company by combining equity with debt financing, with the latter funding a substantial portion of the purchase price. The debt sits on the balance sheet of the acquired company, which services and repays it from its own operating cash flows over the investment period.

Typical financing structure

In a classic LBO, debt accounts for between 50% and 75% of the acquisition price, depending on the sector, cash flow visibility and prevailing credit market conditions. The remainder is contributed by the fund as equity. This structure amplifies the return on invested capital: if the business performs as expected and debt is progressively repaid, the equity return is multiplied through the leverage effect.

The trade-off is risk. A highly leveraged structure is sensitive to any deterioration in cash flows. Funds therefore analyse downside scenarios in detail and require that the company generate sufficient cash to service its debt obligations even under stress conditions. The financial discipline imposed by an LBO is, in many respects, itself a value creation mechanism: it forces efficient management and eliminates inefficiencies that might otherwise be deferred indefinitely.

Target company profile

Not all companies are suitable LBO candidates. Funds generally look for businesses that meet several criteria:

  • Stable and predictable cash flows, with limited cyclicality.
  • Positive normalised EBITDA and reasonable margins relative to the sector.
  • Low pre-existing financial debt, leaving sufficient headroom to accommodate the acquisition leverage.
  • Operational improvement potential: through process integration, digitalisation, geographic expansion or bolt-on acquisitions.
  • A capable management team able to run the business throughout the investment period, or the ability to strengthen it.

Many family-owned businesses in the Spanish mid-market fit this profile: solid companies, well-positioned in their niche, with historically stable margins and cash flows, but with room for improvement in their management structure or growth strategy.

SPVs: The Vehicle That Structures the Transaction

Every private equity transaction is structured through a purpose-built corporate vehicle. The special purpose vehicle (SPV) —typically constituted as an instrumental holding company— is the central piece of that structure: a newly incorporated entity created exclusively to manage the transaction. In an LBO, the fund sets up an SPV which formally takes on the acquisition debt and acquires the shares of the target company. In most cases, that SPV is subsequently merged into the target itself, for reasons explained below.

The key functions of an SPV are fourfold:

  • Risk isolation: the assets and liabilities of the transaction do not contaminate the fund’s balance sheet or those of its other portfolio companies. If the investment underperforms, the impact is contained within the dedicated vehicle.
  • Optimised debt structure: the LBO financing —which may include senior, mezzanine and private debt tranches— is negotiated and held at SPV level, tailored to the target’s cash generation profile.
  • Tax efficiency: the fiscal consolidation between the holding company and the acquired operating entity allows tax losses to be offset and cash flows to be optimised at group level for debt service purposes.
  • Flexibility for complex structures: where co-investors, multiple debt tranches or management equity participation arrangements are involved, the SPV allows that complexity to be accommodated without interfering with the business’s day-to-day operations.

The Tax Treatment of LBOs in Spain: Article 16.5 of the Corporate Income Tax Act

The Spanish tax framework introduces a significant restriction that every fund —and every business owner negotiating with one— should understand. As a general rule, Article 16 of the Corporate Income Tax Act (Ley del Impuesto sobre Sociedades, LIS) limits the deductibility of net financial expenses to 30% of operating profit (adjusted EBITDA), with a guaranteed minimum deductibility floor of €1 million per annum.

However, the key challenge for leveraged mergers lies in paragraph 5 of that same article. In its most restrictive application, it prevents the financial expenses on acquisition debt from being offset against the operating profit contributed by the acquired company, where within four years of the acquisition the target is incorporated into a tax consolidation group or merged with the acquiring entity. Since the SPV holding company has no operating activity of its own, this restriction could in practice entirely neutralise the tax shield benefit of the structure.

The article itself, however, provides a safe harbour that disapplies the restriction where two conditions are met concurrently:

  • Initial leverage cap: the financial debt incurred to acquire the target must not exceed 70% of the total acquisition price.
  • Mandatory annual deleveraging: the debt must be progressively reduced, starting from the tax period following the acquisition, until it reaches a level equivalent to 30% of the acquisition price within a maximum of eight years, with a minimum annual reduction of one-eighth of the difference between the 70% initial and 30% target ratios.

The Spanish Directorate General of Taxation (DGT), in its binding ruling V1664-15, clarified that the annual reduction may be applied flexibly across any of the existing debt tranches —senior, junior, mezzanine or shareholder loans— provided the overall group indebtedness decreases in line with the prescribed thresholds. It also confirmed that extraordinary debt repayments in any given year may be accumulated and carried forward to satisfy the minimum deleveraging requirements of future periods. In practice, this makes the debt repayment schedule as important a planning variable as the interest rate itself.

Value Creation: What Happens After the Acquisition

One of the most common misconceptions about private equity is that returns are generated primarily through leverage. In reality, leverage amplifies returns but does not create them. Value is generated principally during the investment period, through three complementary levers:

  • Operational improvements: the fund works alongside the management team to improve margins, optimise working capital, professionalise procurement, and implement more robust management information systems. In many family-owned businesses, these improvements generate EBITDA growth of between 20% and 40% over a three-to-five-year period.
  • Inorganic growth (Buy & Build): the fund uses the acquired company as a platform to acquire smaller businesses in the same sector, consolidating market position and building scale. These bolt-on acquisitions —typically completed at lower multiples— create value through multiple arbitrage: the consolidated group is ultimately sold at a significantly higher multiple than was paid for the individual components.
  • Debt amortisation: as the company generates cash and reduces its debt, the equity value increases mechanically. Even without meaningful operational improvements, a company that maintains its EBITDA and repays debt is generating returns for the fund.

In the Spanish market, the Buy & Build strategy has underpinned some of the sector’s most successful outcomes. Portobello Capital executed the consolidation of Grupo CTC in the operational outsourcing and logistics sector, building a reference group with revenues exceeding €150 million. Nazca Capital supported Lãberit with a capital increase specifically designed to fund selective corporate acquisitions and consolidate its position in software development. The pattern is consistent: a solid platform company, successive bolt-on acquisitions at lower multiples, and an exit at a higher multiple that captures the full value created.

The Exit Strategy

From the very first day of an investment, the fund is already thinking about its exit. Not because it lacks conviction in the business, but because its mandate is to generate returns for its investors within a defined timeframe —and those returns only materialise upon divestment. The three most common exit routes are:

  • Trade sale: a sale to a strategic buyer in the same or an adjacent sector seeking inorganic growth. This is the most common exit route in the Spanish mid-market.
  • Secondary buyout: the asset is sold to another private equity fund at a different stage of its cycle or with greater capacity to take the business to the next level. Prices in secondary transactions are typically higher than in the initial buyout.
  • Initial public offering (IPO): reserved for larger companies with sufficient market visibility and a compelling growth narrative. Uncommon in the mid-market.

The divestment process is prepared months in advance: updating the business plan, normalising EBITDA, preparing a vendor due diligence report and identifying prospective buyers. The objective is exactly the same as when the fund was on the buy side: maximise the price and minimise the risk of the transaction falling through during the process.

What This Means for the Business Owner Considering a Sale

If you are considering the full or partial sale of your business, understanding the logic of private equity is not an academic exercise: it is information that can materially affect the outcome of the negotiation.

A fund evaluating your company thinks in terms of equity story: what is the improvement potential? How much debt can this business carry on its balance sheet? At what multiple will I be able to sell it in five years’ time? This means that the price offered depends, in part, on the fund’s view of the business’s future potential —not merely on its historical track record.

For the selling business owner, this has several concrete practical implications:

  • EBITDA normalisation is critical. An EBITDA depressed by non-recurring costs, above-market owner remuneration or exceptional capital expenditure can —and should— be adjusted before the sale process begins.
  • Consistency between the equity story and the underlying numbers. If the pitch promises growth potential that the historical data does not support, the buyer will adjust downwards during due diligence.
  • A vendor due diligence report reduces buyer uncertainty and, consequently, the discount the buyer seeks to apply. Entering the process with an up-to-date VDD report is a tangible negotiating advantage.
  • Transaction structure matters as much as price. Selling through a holding company or planning the tax structure in advance can make a difference of several percentage points in the net proceeds ultimately received.

Conclusion

Private equity, leveraged buyouts and SPVs are components of a single financial architecture, designed to acquire businesses, transform them and sell them at a profit. Understanding that architecture —its internal logic, its legal and tax constraints, and its objectives— is relevant whether you are considering selling your business to a fund or simply seeking a deeper understanding of the environment in which you operate.

At Maraz Corporate Finance, we advise business owners and companies across all stages of the M&A process: from valuation and transaction preparation through to negotiation with the buyer and closing. If you are evaluating a corporate transaction, we would be glad to accompany you through the process.

 

Javier de Rojas Roca de Togores

Partner - Maraz Corporate Finance