What is a Leveraged Buyout (LBO)?

A leveraged buyout (LBO) occurs when one company acquires another company using borrowed money.

For an acquisition to be considered an LBO there has to be a high debt to equity ratio (of at least 80% to 20% respectively).

In an LBO the target company’s assets and cash flow are used as the collateral (leverage) to secure and repay the money that was borrowed to make the buyout.

LBOs are very attractive for banks as they can make much higher margins when financially backing an LBO (with high interest) compared to typical corporate lending.

Businesses are attracted to LBOs as they can make a higher percent yield on their equity investment.

LBOs are sometimes considered to be somewhat of a predatory tactic as the target company’s assets can be used against it as collateral.

The first LBOs that took place occurred in the 1950s, with McLean Industries’ acquisition of the Pan-Atlantic Steamship Company in January 1955 and the buyout of the Waterman Steamship Corporation in May 1955.

LBOs carry a weight of risk, as there is the chance that the company making the acquisition won’t be able to repay debt because of overpricing of the target company and its assets or because forecasts of the revenues of the target company were far too optimistic.

In the 1980s there were several LBOs that failed that led to the bankruptcy of the target companies, including Federated Department Stores, Walter Industries, Revco drug stores, Eaton Leonard, and FEB Trucking.

One of the largest LBOs in history was the 2006 $33 billion acquisition of HCA Inc. by Kohlberg Kravis Roberts & Co. (KKR), Merrill Lynch, and Bain & Co.

There are different types of LBOs such as Management Buyouts (MBOs), Management Buy-ins (MBIs), secondary buyouts and tertiary buyouts.

Leveraged Buyout Diagram

leveraged buyout diagram

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