Explore the intricacies of a leveraged buyout, including its definition, the role of private equity firms, the typical debt/equity ratio, the importance of cash flows and operational improvements, and how the cash flow from the acquired company is used.
- A leveraged buyout is the acquisition of a company, using a significant amount of borrowed funds to pay for the purchase price of the company
- The leveraged buyout transaction is orchestrated by a private equity firm (also called a financial sponsor) or group of private equity firms (also called a private equity group or a consortium), which will take ownership (own the equity of) the business after the acquisition has been completed
- Usually, it is a 3-5 year investment horizon, followed by a sale after
- Generally speaking, the debt will constitute a majority of the purchase price after the purchase of the company, the debt/equity ratio is typically around 2.0x or 3.0x (i.e., usually the total debt will be about 60-80% of the purchase price)
- Ability to generate cash flows and repay debt is key
- Operational improvements are integral to increasing cash flows
- In an LBO, the cash flow generated by the acquired company is used to service (pay interest on) and pay down (pay principal on) the outstanding debt. For this reason, while companies of all sizes and industries can be targets of LBO transactions, companies that generate a high amount of cash flow are the most attractive (more on this later)