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The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans or bonds in addition to 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.

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Leveraged buyout is a strategic way through which control of a corporation is acquired by buying up a majority of their stock using borrowed money. A leveraged buyout may also be referred to as a hostile takeover, a highly-leveraged transaction.

Acquire control

(through buying majority stocks)

Pay off

Borrowed Money(Loans/Debentures)

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In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds usually are not investment grade and are referred to as junk bonds. 

LBO Method

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Tax Benefit Minimum cash Outflow

Floating charge against new acquired assests

Interest from future cash inflows

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Low capital & cash Requirement Synergy gains Efficiency gains Leveraging

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In an LBO, the private equity firm acquiring the target company will finance the acquisition with a combination of debt and equity, much like an individual buying a rental house with a mortgage . Just as a mortgage is secured by the value of the house being purchased, some portion of the debt incurred in an LBO is secured by the assets of the acquired business. The bought-out business generates cash flows that are used to service the debt incurred in its buyout, just as the rental income from the house is used to pay down the mortgage. In essence, an asset acquired using leverage helps pay for itself.

In a successful LBO, equity holders often receive very high returns because the debt holders are predominantly locked into a fixed return, while the equity holders receive all the benefits from any capital gains. Thus, financial buyers invest in highly leveraged companies seeking to generate large equity returns. An LBO fund will typically try to realize a return on an LBO within three to five years. Typical exit strategies include an outright sale of the company, a public offering or a recapitalization.

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LBOs lead to downsizing of operations Research and development expenditures

have also been controlled. Further it has been suggested that

management takes advantage of superior information about a firm’s intrinsic value. The evidence, however, indicates that the premiums paid in leveraged buyouts compare favorably with those in inter-firm mergers that are characterized by arm’s-length negotiations between the buyer and seller.

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If private company will takeover the public company it will come under the LBO

The guidelines for LBO is given by RBI The objective of bussiness financial investor

is to exit the investment after 3-7 years. Internal Rate of Return (‘IRR’) of in excess of

20% on its investment The target company goes private after a LBO.

The ratio of the debt owed by the company is not more than twice the capital and free reserves after such buy-back

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Table : List of buyouts by Indian companies

Target Company Country Indian Acquirer Value Type Tetley United Kingdom Tata Tea ₤271 million LBO Whyte & Mackay United Kingdom UB Group ₤550 million LBO Corus United Kingdom Tata Steel $11.3 billion LBO Hansen Transmissions Netherlands Suzlon Energy €465 million LBO American Axle1 United States Tata Motors $2 billion LBO Lombardini2 Italy Zoom Auto Ancillaries $225 million LBO

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Large positive abnormal returns  Large excess returns over the period from

the buyout 

high levels of debt company’s credit rating

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