Curious about LBOs? Wondering what is an LBO? It’s a financial strategy used by companies to acquire other businesses, but it can also be a risky proposition.
In this article, we will explore what it is, how does a leveraged buyout work, and the potential benefits and drawbacks of using this strategy.
Whether you’re an investor or just interested in learning more about finance, read on to discover what is an LBO and the ins and outs of leveraged buyouts.
What is Leveraged Buyout (LBO)
A leveraged buyout (LBO) is a financial transaction in which a company is acquired with a significant amount of borrowed money or debt.
If you’re wondering how to do a leveraged buyout, it usually involves the acquiring company, which can be a private equity firm or a group of investors, using the assets of the acquired company as collateral for loans. These loans are then paid off using the cash flows generated by the company.
LBOs are often used as a way for companies to grow or acquire other businesses, but they can also be used as a way to take a public company private. While LBOs can be risky, they can also provide significant returns for investors if executed correctly.
Leveraged Buyouts Brief History
Leveraged buyouts, or LBOs, first emerged in the 1960s as a way for investors to acquire companies using a combination of debt and equity. In the 1980s, LBOs became increasingly popular as a way for companies to go private and restructure their operations.
The 1990s saw a decline in LBO activity due to economic downturns and increased regulation. However, LBOs made a comeback in the early 2000s, particularly in the private equity industry, and continue to be an important tool in corporate finance today.
Examples of Leveraged Buyouts
There have been several notable LBOs throughout history. One of the most famous LBOs was the acquisition of RJR Nabisco in 1988, which was the subject of the book “Barbarians at the Gate.”
Other well-known LBOs include the acquisition of Hilton Hotels by the Blackstone Group in 2007 and the acquisition of Dell by Silver Lake Partners in 2013. LBOs have been used in a variety of industries, including retail, healthcare, and technology.
While LBOs can be controversial due to the high levels of debt involved, they remain a popular method of financing large acquisitions in the corporate world.
Types of Leveraged Buyouts
There are three main types of leveraged buyouts:
- Management buyouts (MBOs)
- Management-led buyouts (MLBOs)
- Leveraged recapitalizations
MBOs
This type of LBO occurs when a company’s management team buys out the company with the help of a private equity firm or other financial institutions.
Among the most successful MBOs in recent decades was Sports Authority’s acquisition by its management team in 2016. Sports Authority filed for bankruptcy at the time because of financial difficulties.
Rather than sell to an outside buyer, the CEO and management team proposed an MBO that would allow them to take control of the company. Through a group of lenders, the team had been able to raise $1.3 billion for the MBO. However, Sports Authority ultimately failed to regain profitability and closed all of its stores.
Management-led buyouts (MLBOs)
In this type of LBO, the management team and a private equity firm collaborate to buy out the company. A real-time example of a management-led buyout (MBO) is the acquisition of Ancestry.com by a group of private equity firms led by Silver Lake and GIC.
In 2020, the group acquired the genealogy and family tree website from Permira for $4.7 billion in an MBO deal. The Ancestry.com management team also invested in the transaction alongside the private equity firms.
The MBO allowed the management team to gain full control of the company and execute its strategic plans without the pressures of being a publicly traded company. The private equity firms provided the necessary financing and expertise to support the MBO.
The transaction was one of the largest MBO deals in recent years and demonstrated the continued popularity of this type of transaction among management teams looking to take control of their companies.
Leveraged Recapitalizations
This type of LBO involves a company borrowing heavily to pay a large dividend to its shareholders or to repurchase its shares. This increases the company’s debt level and puts it at higher risk, but it can also be a way to unlock value for shareholders.
One example of a leveraged recapitalization is the case of Dell Inc. in 2013. The company underwent a leveraged recapitalization in order to finance a $24.4 billion deal to take the company private.
In this transaction, Dell borrowed a significant amount of money, using its assets as collateral, in order to pay a special dividend to shareholders. The goal of the transaction was to reduce the number of outstanding shares and allow the company to focus on longer-term goals without the pressure of satisfying short-term investors.
The transaction was completed with the help of private equity firm Silver Lake, and ultimately resulted in Dell becoming a privately held company. The move allowed the company to focus on growth and diversification, rather than the pressures of quarterly earnings reports and Wall Street expectations.
Reasons Why Business Owners Consider Leveraged Buyouts
Business owners consider leveraged buyouts for various reasons, including:
- Liquidity: LBOs provide an opportunity for business owners to cash out their investments and realize liquidity.
- Growth Opportunities: LBOs allow companies to grow through acquisitions, expansions, and other strategic investments.
- Cost Of Capital: LBOs may provide a lower cost of capital compared to other financing methods such as equity financing or traditional debt financing.
- Control: Business owners can retain control over their company even after selling a portion of the company through an LBO.
- Tax Benefits: LBOs may provide tax benefits to business owners, such as the ability to deduct interest payments on debt financing.
Benefits and Risks of LBOs?
Learning what is an LBO requires understanding its benefits and risks.
Benefits of LBOs
- Allows companies to make large acquisitions without committing significant amounts of their capital
- This can result in increased efficiency and profitability due to a greater focus on cash flow and cost-cutting measures
- Can provide significant returns for private equity firms and their investors
Risks of LBOs
- High levels of debt can make the company vulnerable to economic downturns and fluctuations in interest rates
- Cost-cutting measures can lead to job losses and a decrease in employee morale
Private equity firms may prioritize short-term gains over long-term growth, potentially harming the company’s prospects
Those involved in SWAPS in LBOs are typically the private equity firm and the company being acquired. The private equity firm will often use SWAPS to manage its risk exposure and hedge against potential losses.
Conclusion
In conclusion, a leveraged buyout (LBO) is a financial strategy that allows a company to use a significant amount of debt to acquire another company or to take itself private.
LBOs have been used by businesses for decades, and while they can be a valuable tool, they also come with significant risks and challenges.
To determine what is an LBO, investors and business owners must carefully consider the benefits and drawbacks of LBOs and evaluate their specific circumstances.
Ultimately, a successful LBO requires careful planning, execution, and ongoing management to ensure long-term success.