Loading the player...

What is 'Leveraged Buyout - LBO'

A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the assets of the acquiring company. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

BREAKING DOWN 'Leveraged Buyout - LBO'

In a leveraged buyout (LBO), there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds issued in the buyout are usually are not investment grade and are referred to as junk bonds. Further, many people regard LBOs as an especially ruthless, predatory tactic. This is because it isn't usually sanctioned by the target company. It is also seen as ironic in that a company's success, in terms of assets on the balance sheet, can be used against it as collateral by a hostile company.

Reasons for LBOs

LBOs are conducted for three main reasons. The first is to take a public company private; the second is to spin-off a portion of an existing business by selling it; and the third is to transfer private property, as is the case with a change in small business ownership. However, it is usually a requirement that the acquired company or entity, in each scenario, is profitable and growing.

History of LBOs

Leveraged buyouts have had a notorious history, especially in the 1980s, when several prominent buyouts led to the eventual bankruptcy of the acquired companies. This was mainly due to the fact that the leverage ratio was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet the obligation. One of the largest LBOs on record was the acquisition of Hospital Corporation of America (HCA) by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co. and Merrill Lynch in 2006. The three companies paid around $33 billion for the acquisition of HCA.

An LBO in Process

LBOs are often complicated and take a while to complete. For example, JAB holding company, a private firm that invests in luxury goods, coffee and healthcare companies, initiated an LBO of Krispy Kreme Doughnuts, Inc. in May 2016. JAB was slated to purchase the company for $1.5 billion, which included a $350 million leveraged loan and a $150 million revolving credit facility provided by the Barclays investment bank.

However, Krispy Kreme had debt on its balance sheet that needed to be sold, and Barclays was required to add an additional 0.5% interest rate in order to make it more attractive. This made the LBO more complicated and it almost didn't close. However, as of July 12, 2016, the deal went through.

RELATED TERMS
  1. Institutional Buyout - IBO

    An institutional buyout is the acquisition of a controlling interest ...
  2. Acquisition

    An acquisition is a corporate action in which one company buys ...
  3. Covenant-Lite Loans

    Covenant-lite loans are a type of loan given with limited restrictions ...
  4. Net Leverage (Insurance)

    Net leverage is the sum of an insurance company’s net premiums ...
  5. Operating Leverage

    Operating leverage is the degree to which a firm or project can ...
  6. Shared National Credit Program

    The national credit program was created in 1977 to provide an ...
Related Articles
  1. Managing Wealth

    Investing in Leveraged Buyouts: Know the Risks

    Leveraged buyouts allow investors to make large acquisitions without a lot of capital. But LBOs carry big risks and result in huge returns or losses.
  2. Investing

    Understanding Leveraged Buyouts

    LBOs are often presented as predatory by the media, but it really depends on which side of the deal you're on.
  3. Tech

    10 Most Famous Leveraged Buyouts

    Learn about the boldest, riskiest leveraged buyouts in history and how they either become famous for failing miserably or making billions.
  4. Investing

    Keurig Owner JAB Holdings Buying Krispy Kreme

    JAB Holding Co. has been quietly creating a coffee empire that's well-positioned to take on industry leaders like Dunkin' Donuts (NASDAQ: DNKN).  The not-very-well-known firm recently completed ...
  5. Insights

    How Henry Kravis Built Private Equity Giant KKR

    An overview of how Henry Kravis built one of the world's largest private equity firms.
  6. Investing

    Leverage: Is It Good for Your Portfolio?

    Discover the concept of financial leverage. Learn multiple ways to get leverage in your portfolio, and decide if leverage is a good idea for you.
  7. Investing

    Krispy Kreme Expands Its Grocery Store Push (KKD, DNKN)

    Following its major coffee rivals Dunkin' Donuts and Starbucks, Krispy Kreme Donuts (NYSE: KKD) has extended its reach to grocery stores. The company -- famous for having hot doughnuts when ...
  8. Investing

    4 Ways Millennials Can Buy Private Businesses

    Buying private businesses is a good way to have greater control over your investments while increasing your income and avoiding the fluctuations of the market.
  9. Trading

    Forex leverage: A double-edged sword

    Find out how leverage, a flexible and customizable tool, magnifies both gains and losses in the forex markets.
RELATED FAQS
  1. Why Isn't My Stock Trading at the Buyout Price?

    An acquisition or merger does not necessarily mean the deal will be resolved as originally stated. Read Answer >>
  2. Can mutual funds use leverage?

    Learn about what types of mutual funds use leverage, how leverage can increase returns and what restrictions are in place ... Read Answer >>
  3. How company stocks move during an acquisition

    During an acquisition, there's a short-term impact on the stock prices of both companies. Typically, the target company's ... Read Answer >>
  4. What are financial risk ratios and how are they used to measure risk?

    Explore some of the primary financial risk ratios that investors and analysts commonly use to evaluate a company's overall ... Read Answer >>
  5. How can an investor evaluate the leverage of an insurance company?

    Learn about insurance leverage, what leverage means in the context of insurance companies and what metrics investors should ... Read Answer >>
Trading Center