Understanding Leveraged Buyouts (LBOs)
In the business world, it is common to see acquisitions and mergers. Some of these are done through cash or share buyouts. There is another buyout strategy out there that has brought on quite the controversy. It is known as the Leveraged Buyout. This is commonly used in private equity funds.
Leveraged Buyout Defined
An LBO is basically a way for a company to buy out another company without having to use much of their own money. This works if the company that is buying out the other company has a good amount of positive cash flow and a high level of valuable assets and low level of debt.
Basically, the buyer will essentially use debt against company assets in order to buy the business. The debts are used to buy interest in the business.
Why Choose LBO?
The company that is actually buying out the other company has basically leveraged the purchase of the business without forking out a lot of their own money. Their main goal is to improve the business in an effort to be able to sell it later and make a profit. The company will have more debt, but if they are successful in growing the business they will be able to pay off these debts.
A Good Example
Company A is interested in purchasing Company B. If Company A wanted to use the Leveraged Buyout strategy, then they will want to base their offer on the amount of cash flow and the amount of debt that is owed by Company B. Company A would create a new company, known as Company C, and would look to lenders for loans to help cover the price of the new company using the assets as collateral. Company C would then be responsible for paying off these loans. Once the ownership has been moved, Company B will then be known as Company C. It will allow them to improve the cash flow and pay off the debts.
The Risks Involved
LBOs definitely have their risks. The biggest risk is the fact that there will be more debt on the buying company, which can cause a significant financial burden. This risk can definitely be reduced if they take their time and make wise financial decisions, but ultimately the risks are very real and something could always happen that would cause the company to result in insolvency.