Leveraged Buyout
IntermediateA leveraged buyout is the acquisition of a company using a large amount of borrowed money to pay for the purchase, with the target company's assets and cash flows typically used to support and repay the debt.
Leveraged buyouts, often shortened to LBOs, are commonly carried out by private equity firms. The buyer contributes a portion of the purchase price as equity and borrows the rest. The debt is placed on the acquired company, which must use its cash flows to pay the interest and repay the loans.
Using borrowed money magnifies returns on the equity invested. For example, a private equity firm buys a company for 100 million, using 30 million of equity and 70 million of debt. Over five years, the company's cash flows reduce the debt to 40 million, and the firm sells the company for 150 million. After repaying the remaining debt, the equity is worth 110 million, about 3.7 times the original 30 million invested.
Suitable targets for LBOs usually have stable, predictable cash flows, strong market positions, limited need for heavy investment and opportunities for operational improvement.
The heavy debt also magnifies risk. If the company's performance weakens or interest rates rise, it may struggle to meet its debt payments, potentially leading to financial distress or bankruptcy. Critics argue that LBOs can weaken companies, while supporters say the discipline of debt and active ownership can improve performance.
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