What Is a Leveraged Buyout?

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.

Key Takeaways

  • A leveraged buyout is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. 
  • Leveraged buyouts declined in popularity after the 2008 financial crisis, but they are once again on the rise.
  • In a leveraged buyout (LBO), there is usually a ratio of 90% debt to 10% equity.
  • LBOs have acquired a reputation as a ruthless and predatory business tactic, especially since the target company's assets can be used as leverage against it.
1:17

Leveraged Buyouts

Understanding 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 not investment grade and are referred to as junk bonds. LBOs have garnered a reputation for being an especially ruthless and predatory tactic as the target company doesn't usually sanction the acquisition. Aside from being a hostile move, there is a bit of irony to the process in that the target company's success, in terms of assets on the balance sheet, can be used against it as collateral by the acquiring company.

The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

LBOs are conducted for three main reasons:

  1. to take a public company private.
  2. to spin-off a portion of an existing business by selling it.
  3. 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.

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.

Example of Leveraged Buyouts (LBO)

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 valued HCA at around $33 billion.

Although the number of such large acquisitions has declined following the 2008 financial crisis, large-scale LBOs began to rise during the COVID-19 pandemic. In 2021, a group of financiers led by Blackstone Group announced a leveraged buyout of Medline Inc., that valued the medical equipment manufacturer at $34 billion. As reported in the Wall Street Journal, the size of the deal suggested that "the appetite for megadeals is rising...and private-equity firms look to deploy mountains of cash."

How Does a Leveraged Buyout (LBO) Work?

A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition. The debt/equity ratio is usually around 90/10 which relegates the bonds issued to be classified as junk. Aside from being a hostile move, there is a bit of irony to the LBO process in that the target company's success, in terms of assets on the balance sheet, can be used against it as collateral by the acquiring company. In other words, the assets of the target company are used, along with those of the acquiring company, to borrow the needed funding that is then used to buy the target company.

Why Do Leveraged Buyouts (LBOs) Happen?

LBOs are primarily conducted for three main reasons: to take a public company private; to spin-off a portion of an existing business by selling it; and to transfer private property, as is the case with a change in small business ownership. The main advantage for the acquirers is that they can put up a relatively small amount of their own equity and, by leveraging it with debt, raise the capital to initiate a buyout of a more expensive target.

What Type of Companies Are Attractive For LBOs?

LBOs have garnered a reputation for being an especially ruthless and predatory tactic as the target company doesn't usually sanction the acquisition. That said, attractive LBO candidates typically have strong, dependable operating cash flows, well established product lines, strong management teams, and viable exit strategies so that the acquirer can realize gains.