A leveraged buyout (LBO) is a business deal that occurs when one company acquires another using a significant amount of debt. These transactions usually arise when a private equity (PE) firm borrows 70%-90% of the purchase price from diverse lenders and funds the balance with their own equity. The buyer safeguards that debt with the assets of the company they’re acquiring and the company being acquired assumes that debt.
The buyer acquires the assets of the target company, which are positioned in a new commercial entity intended to hold the assets and run the business.
Example of a Leveraged Buyout
Lois owns an investment body and would like to acquire Gemmyz, a hotel chain. She intends to restructure the company into a more lucrative operation instead of selling it.
Their agreement was a buying price of $100 million. To conduct a leveraged buyout, Lois, first of all, commits $10 million of her business’s money. She then gets a bank loan for the remaining $90 million.
Lois’ firm is negotiating this loan, but it will soon own Gemmyz. So, the loan is structured such that Gemmyz will undertake this debt. The bank will thereafter secure its $90 million with Gemmyz assets. This implies that Gemmyz will be accountable for making all payments on the debt that Lois used to buy it, and if Gemmyz fails to pay it back, the bank will seize its land, record, and other assets in place of payment.
Frequently Asked Questions
What is the main source of financing for leveraged buyouts?
LBO is the purchase of another company using a noteworthy amount of loaned money to meet the cost of purchase. The debt/equity percentage is usually around 90/10 which denotes the bonds issued as junk. Hence, the main source of financing for LBO is borrowed funds.
Why do leveraged buyouts (LBOs) happen?
LBOs are mostly conducted for these main reasons – to take a public company private; to offshoot a portion of an existing business by selling it, and to transfer private possessions.
What types of companies are attractive for LBOs?
Attractive LBO companies typically have solid, reliable functioning cash flows, refutable product lines, strong administrative teams, and feasible exit policies so that the buyer can realize gains.
What does a buyer purchase in a leveraged buyout transaction?
In a leveraged buyout transaction, a buyer purchases an existing company which in turn becomes an asset.
Are leveraged buyouts bad?
The risks of a leveraged buyout are high. Interest rates on the acquired loans are usually high and can result in a lower credit rating. If they’re unable to pay back, the aftermath is bankruptcy.
How are leveraged buyouts financed?
Leverage buyouts can be financed based on their size and complexity:
1. Seller Financing
Smaller transactions typically have a seller financing component. Most sellers propose this option to accommodate the demands of the buyer. Buyers prefer the seller’s financing in the transaction as it bonds the seller to the business’s performance during the loan period.
2. SBA-Backed Loans
The most operative way to fund a transaction within the range of $5 million is with an Small Business Administration-backed loan.
3. Small Investors and Family Offices
Some transactions are funded with loans from individual investors and family offices. Nevertheless, finding this type of lender is challenging. They are usually found by personal influences, recommendations, and networking.
4. Bank Financing
Buyers who predict the need for financing in the first few years of operation should get post-acquisition funding in collaboration with their business acquisition loan.
Another Great Use of Leverage
LBO occurs when someone purchases a company by acquiring debt. The purchaser secures that debt with the company’s assets. The basic purpose of leveraged buyouts is to enable companies to make large acquisitions without having to obligate a lot of capital.