Leveraged buyout

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A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or "bootstrap" transaction) occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage (borrowing). The assets of the acquired company are used as collateral for the borrowed capital, sometimes with assets of the acquiring company. Typically, leveraged buyout uses a combination of various debt instruments from bank and debt capital markets. The bonds or other paper issued for leveraged buyouts are commonly considered not to be investment grade because of the significant risks involved.[1]

Companies of all sizes and industries have been the target of leveraged buyout transactions, although because of the importance of debt and the ability of the acquired firm to make regular loan payments after the completion of a leveraged buyout, some features of potential target firms make for more attractive leverage buyout candidates, including:

  • Low existing debt loads;
  • A multi-year history of stable and recurring cash flows;
  • Hard assets (property, plant and equipment, inventory, receivables) that may be used as collateral for lower cost secured debt;
  • The potential for new management to make operational or other improvements to the firm to boost cash flows;
  • Market conditions and perceptions that depress the valuation or stock price.

Contents

Characteristics

Leveraged buyouts involve an investor, financial sponsors or private equity firms making large acquisitions without committing all the capital required for the acquisition. To do this, a financial sponsor will raise acquisition debt which is ultimately secured upon the acquisition target and also looks to the cash flows of the acquisition target to make interest and principal payments. Acquisition debt in an LBO is therefore usually non-recourse to the financial sponsor and to the equity fund that the financial sponsor manages. Furthermore, unlike in a hedge fund, where debt raised to purchase certain securities is also collateralized by the fund's other securities, the acquisition debt in an LBO is recourse only to the company purchased in a particular LBO transaction. Therefore, an LBO transaction's financial structure is particularly attractive to a fund's limited partners, allowing them the benefits of leverage but greatly limiting the degree of recourse of that leverage.

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