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. Reverse Leveraged Buyout

    A reverse leveraged buyout occurs when a business that went private ...
  2. Buyout

    A buyout is the acquisition of a controlling interest in a company ...
  3. Going Private

    Going private is a transaction or a series of transactions that ...
  4. Leveraged Loan

    Loans extended to companies or individuals that already have ...
  5. Leveraged Recapitalization

    Leveraged recapitalizations replace most of a company's equity ...
  6. Leverage

    Leverage results from using borrowed capital as a source of funding ...
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. Investing

    The Most Famous Leveraged Buyouts

    A look at the largest and most famous leveraged buyouts in history.
  4. Investing

    The Biggest Private Equity Firms in New York City

    Discover the top four largest private equity firms, including Goldman Sachs, headquartered in New York City, as ranked by total assets raised since 2010.
  5. Trading

    How leverage works in the forex market

    Investors use leverage to significantly increase the returns that can be provided on an investment and companies use leverage to finance their assets.
  6. Investing

    World's Top 10 Private Equity Firms (APO, BX)

    Obtain important information about the world's top ten private equity firms ranked as of 2015, including their investment focus and portfolio assets.
  7. Investing

    10 Most Famous Public Companies That Went Private

    Here’s a list of the most popular listed companies that went private in recent decades.
  8. Investing

    Operating leverage captures relationships

    Find out how fixed and variable costs interact to shed new light on old companies.
  9. Insurance

    Key Players In Mergers And Acquisitions

    Strategic acquisition is becoming a part of doing business. Discover the different types of investor groups involved.
  10. Investing

    The Top 5 Positions in Henry Kravis and George Roberts' Portfolio (KKR, WBA)

    Discover the top five holdings in Henry Kravis and George Roberts' portfolio to see if these stocks can boost your portfolio in 2016.
RELATED FAQS
  1. How are leveraged buyouts financed?

    Understand the basics of a leveraged buyout, who is involved in executing the transaction and some of the various ways to ... Read Answer >>
  2. What are some examples of successfully executed leveraged buyouts?

    Learn about one of the most successful leveraged buyouts in corporate history that led to large profits for investors who ... Read Answer >>
  3. 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 >>
  4. What is the difference between operating leverage and financial leverage?

    Discover the two equity valuation metrics, operating leverage and financial leverage, how they are similar and what differentiates ... Read Answer >>
  5. 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 >>
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  4. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  5. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  6. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
Trading Center