Leveraged Buy Out (LBO) is a transaction in which a business enterprise, or controlling share of a company, is purchased using borrowed money by pledging all or part of its assets as collateral.
The company performing the LBO or takeover only has to provide a small amount of the financing (usually around 90% of the cost is financed through debt) yet is able to make a large purchase, hence the name ‘Leveraged’. Leverage is a tool that enables one to trade a larger amount of money, having only a fraction of the amount. For example, with 1: 100 leverage, you can run a business of 100,000 USD volume, having just 1,000 USD of your own funds. This usually follows a 70% to 30% equity ratio. LBO is basically a strategy whereby a company acquires another company and to fulfill the acquisition of fees using borrowed money such as bonds and loans. the big companies and acquired company assets are used as collateral to get the loan. As an investor, you can be a part of LBO either by buying debt or by buying equity.
The purpose of LBO is companies are able to make large acquisitions with small amount of capital. The acquirers also want to maximize shareholder value by attempting to create a stronger and more profitable combined entity. The buyer needs to ensure that the expected synergies materialize in order to realize financial returns. In the context of LBO, the leverage account contains a small portion of the capital and a substantial portion of the loan capital. Loan capital is generally borrowed through banks and public / private bonds placed.
In this case, the debt appears on the balance sheet of the acquired company and the cash flows are used to repay the debt.The LBO option provides results that benefit the investment, almost 20%. This happens when a major corporate restructuring takes place and the financial guarantor sells shares in a public offering or sells a major company to another company.