What is a Leveraged Buyout?

A leveraged buyout (LBO) is when one company purchases another using mainly debt rather than equity.

Usually, the acquired company’s assets are used as collateral. This allows companies to make large acquisitions without needing to commit much capital. Typically, a leveraged buyout involves a ratio of 90% debt to 10% equity, though this can vary.

Why do companies use leveraged buyouts?

Leveraged buyouts can be used as a form of hostile takeover, though this isn’t always the case. LBOs are also used to take a public company private, to break a large business into smaller parts, and to transfer a small business from one owner to another.

From the perspective of the target company, a leveraged buyout lets them get a good price for their business — this means it can be part of their exit strategy.

As with any type of takeover, companies will look for good opportunities. The target company needs to be profitable and growing to ensure the LBO’s success. This means that LBO targets are usually companies with strong, dependable cash flows that can pay off the debt balance, established product lines, and experienced management teams.

Can the existing management or employees use a leveraged buyout on their company?

Yes, it’s possible for the company’s own management or even employees to buy the company using an LBO. This is called a “savior plan” and involves the management and employees borrowing money to invest in the company in an attempt to save it. This is most common among small startups, rather than larger companies.

Are leveraged buyouts bad?

Leveraged buyouts aren’t a bad thing, but they’re viewed that way in some cases. In the 1980s, leveraged buyouts often involved borrowing up to 100%, with companies putting no money down at all and financing the whole deal using loans and bonds. The huge monthly loan payments meant that some companies went bankrupt.

Leveraged buyouts have often been seen as predatory, particularly when they lead to the acquired company being split up into separate parts — as this often involves mass layoffs. However, this can potentially allow the individual parts of the company to operate more efficiently, freed from a complex large corporate structure.

How does a company get financing for a leveraged buyout?

It’s not so easy to get a loan for a leveraged buyout as it once was. The acquiring company will need to build a financial forecast for the target company (normally for the next five years) and take this to banks or other lenders to secure a loan and to agree on the debt financing.

When one company purchases another using debt rather than equity, it’s known as a leveraged buyout. Leveraged buyouts are used for several purposes, such as to take a public company private or to transfer ownership of one company to another. To ensure success, a company purchased in a leveraged buyout should have good financial standing.