Leveraged buyouts occur when one company acquires a target company using working capital from lenders to maintain cash flow and set the amount of debt.
What Is a Leveraged Buyout?
A leveraged buyout (LBO) is a type of corporate acquisition in which one company borrows money to purchase another. The assets of the acquired company can be used as collateral for loans and debt financing. Private equity firms frequently contribute to these efforts because they see high-yield financial promise in the acquired company, which will eventually serve their corporate finance.
To be successful, LBOs necessitate a significant amount of time, collaboration, and resources. A board of directors will assist in overseeing this type of mergers and acquisitions, keeping finances straight and ensuring partnerships are well-maintained so that a company's restructuring and valuation result in a profitable rate of return for all parties involved.
Leveraged Buyout Example
Several companies have taken part in LBOs, some of which have become public affairs. The 1980s, for example, saw a period of hostile takeovers in which wealthy business people engaged in intense bidding wars to acquire and restructure smaller companies. In 1989, the global investment firm Kohlberg Kravis Roberts & Co. (KKR) completed a $31.1 billion takeover of RJR Nabisco, which was the largest LBO in history at the time.
3 Types of Leveraged Buyouts
LBOs are classified into several types, including:
1. Management buy-in (MBI): An external company acts as the purchasing party in an MBO. This party will see the company's profitability and will come in and purchase larger shares to assert dominance and direction. The assets of the target company serve as collateral for others to invest in it.
2. Management buyout (MBO): This type of LBO occurs when the company's ownership wishes to retire and sell the company to a trusted management team. Owners will devise an exit strategy and set the purchase price so that management can purchase a significant portion of the company. The remainder of the funding will be provided by management through investment banking or equity financing.
3. Secondary buyout: A secondary buyout happens when both the buyer and seller of a company are financial supporters or firms, and they use an LBO to acquire an LBO. When interest rates and equity returns make it a good time to sell, or when sales to strategic buyers and IPOs are impossible for small businesses, secondary buyouts generate more liquidation.
How Do Leveraged Buyouts Work?
A leveraged buyout occurs when a company sells itself or when interested buyers approach the company. That purchasing company will be able to pay a set amount—not the entire purchase price—and then turn to an outside firm or financial sponsors to put down the remaining funds. In this hypothetical example, consider the general stages of an LBO:
1. Purchase: An entrepreneur may purchase a public company that is going out of business, recognizing that the company requires restructuring in order to be profitable. The entrepreneur approaches a well-known real estate firm for assistance in financing the remainder of the company.
2. Restructuring: The buyers have several options for structuring the debt. Senior debt is secured by the company's assets and has the lowest interest margins. Junior debt, also known as mezzanine financing, will carry a higher interest rate. High-yield bonds may be used to replace these debts in some cases, and in larger purchases, more than one company may be involved in the financing.
3. Payout: Financiers become shareholders and are in charge of the purchased company's finances. Before taking a cut of the company's profits over time, the financiers are the first to recoup their investment. The initial financing is the first step toward a more excellent long-term payoff.