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.
 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.)