Question

What makes a LBO a LBO?

Answer 1

As the name would imply a leverage buy out is using financial leverage or debt as the principal element in an acquisition. In simple words LBO refers to the takeover of a company while utilizing mainly debt in order to buy the company. The debt is raised keeping the assets of the target company as collateral also the acquired firm’s cash flow is used to pay off the debt. LBO’s work on an anticipation that the returns generated on the purchase will be greater than that of the interest to be paid on the debt. Hence the acquirer will be able to experience good returns by investing only a small part of its own capital. The investors or the acquirers as they say usually sell the firm four to seven years from when they purchase it and exit it with a profit. This is how usually LBO works.

In order to execute an LBO deal it requires the experience, credibility to secure the funds and the confidence of financing sources. But that comes later, what is required first is a good LBO candidate. Every company cannot be considered as a viable LBO target, there are certain peculiarities which makes a company one. When the sponsor is evaluating the potential LBO candidate, they focus on its key strength and risk areas. Usually these LBO’s are underperforming divisions of a company, companies who are in fragmented markets that require a new strategy or the troubled company that require a turnaround. Regardless of the situation, What Makes Good Leverage Buyout revolves around the basic purpose which is the ability to pay back the debt used to buy the firm with the target firm’s cash flow.