Leveraged Buyout

Writen by David Gass

As a small business owner, you must have knowledge of various financial issues and investment options. In the primary and secondary markets, you must have come across the term LBO, or Leveraged Buyout, several times. You may perhaps know what leveraged buyout is, but you may not have enough knowledge about its working. So, as an investor as well as a businessman, have a look at LBO and its various aspects.

Leveraged Buyout- What Is This? A typical dictionary definition of this term is "a debt-financed transaction, usually via bank loans and bonds, which aims at taking a public corporation private." In simple terms, a LBO takes place when a financial supporter gets control over a majority of a company's equity through the use of borrowed money or debt. Leveraged buyout is also known as high-leveraged transaction or bootstrap transaction.

It usually follows a ratio of 70% debt to 30% equity. LBO is basically a strategy in which a company acquires another company and in order to meet the acquisition costs it uses borrowed money like bonds and loans. Major companies as well as acquired companies assets are used as security for getting such loans.

As an investor, you can be a part of LBO either by purchasing the debt or by purchasing equity. There are mainly three types of transactions in the LBO market:

The transactions in which a public company is taken private,

The divestures that result from selling off divisions of a public conglomerate,

Private market transactions that involve companies whose stocks are not publicly traded.

In the context of LBO, a leveraged balance sheet contains a little portion of equity capital and a major portion of loan capital. The loan capital is generally borrowed through banks and public/privately placed bonds. In this case, the debt appears on the acquired company's balance sheet and its cash flow is used to pay back the debt.

The LBO option gives lucrative returns on investment, nearly 20%. It happens when a major corporate restructuring takes place and the financial guarantor sells shares in a public offering or sells the main company to another company.

On one side, LBO can make more efficient use of company's resources; but on the other hand, it can also cause great economic suffering. Despite this, a recent market study says that the market is quite friendly to LBO activities.

Whatever the case, as an investor you should have knowledge of LBO. It will surely help you in your portfolio management. If you are eager to know more about it, fix a meeting with a market expert or start searching the Internet for useful details.

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