What is Leveraged Buyout?
Infamous for being a hostile takeover tactic, this type of buy-out entails using large amounts of debt.
Leveraged Buyout or LBO, in simple terms, means using borrowed money (debt) for the acquisition of a company. Very often, the assets of the company being acquired are used as collateral to acquire debt. The borrowed money, or debt, could be in the form of either loans or bonds.
LBO is useful for doing the following:
The main objective of LBO is to be able to acquire without dedicating a large amount of money. Infamous for being a hostile takeover tactic, this type of buy-out entails using large amounts of debt (generally, 90 per cent debt and 10 per cent equity).
Using higher leverage (debt) enhances the return on equity (for the acquirer company). Moreover, the debt is strapped to the acquired company and not the acquirer. This mitigates the risk of tight cashflows and downturn in the economy causing losses to the acquired company as its assets can be sold off to pay the debt.
Ideally, only companies that are mature, stable, non-cyclical, and have predictable cashflows are good prospects for a leveraged buyout. This is because a steady cash flow is essential for servicing the huge debt, which is strapped to the company post LBO.