An LBO, or leveraged buyout, is a financial transaction in which one company acquires another using a significant amount of borrowed money to finance the acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the cash flow of the company. The term LBO is usually employed when a financial sponsor acquires a company, but many corporate transactions are partially funded by bank debt, thus effectively also representing an LBO. LBOs can have many different forms such as management buyout (MBO), management buy-in (MBI), secondary buyout, and tertiary buyout, among others, and can occur in growth situations, restructuring situations, and insolvencies. LBOs mostly occur in private companies, but can also be employed with public companies (in a so-called PtP transaction – public-to-private) .
Some key features of LBOs include:
- Significant amount of borrowed money: LBOs are characterized by the use of a large amount of borrowed money to finance the acquisition.
- Collateral: The assets of the company being acquired are often used as collateral for the loans.
- High debt-to-equity ratio: In an LBO, there is usually a ratio of 90% debt to 10% equity.
- Junk bonds: Because of the high debt/equity ratio, the bonds issued in the buyout are usually not investment grade and are referred to as junk bonds.
- Win-win situation: LBOs usually represent a win-win situation for the financial sponsor and the banks: the financial sponsor can increase the rate of returns on its equity by employing the leverage; banks can make substantially higher margins when supporting the financing of LBOs as compared to usual corporate lending, because the interest chargeable is that much higher.
LBOs can be used to make a public company private or to spin off a portion of an existing business by selling it. They can also be used to transfer private property, such as a change in small business ownership. The main advantage of an LBO is that the acquiring company can purchase a much larger company, leveraging a relatively small portion of its own assets. LBOs have clear advantages for the buyer: they get to spend less of their own money, get a higher return on investment, and help turn companies around. They see a bigger return on equity than with other buyout scenarios because they’re able to use the seller’s assets to pay for the financing cost rather than their own. An LBO can also lower a business’ taxable income, so that the buyer realizes tax benefits they didn’t have before.
