LBO

An leveraged buyout (LBO) is a financial transaction in which a controlling interest in a company is purchased primarily with borrowed funds. The assets of the target company, and often the acquiring entity, serve as collateral for the debt. A private equity sponsor typically contributes a minority equity stake, while debt provides the majority of the purchase price. The expectation is that the target’s cash flows will service the debt, and that operational improvements or multiple expansion at exit will produce a high return.

Financing structures in an LBO usually mix several layers of debt with a smaller equity contribution. Senior secured debt carries priority for repayment, while subordinated debt or mezzanine finance absorbs more risk but offers higher returns. The borrower’s cash flows must cover debt service and covenants, which can constrain operations. Equity sponsors, and often management, provide the remaining capital and may tie its compensation to performance.

Process and objectives: identify a target with stable or predictable cash flows and potential for efficiency gains or strategic repositioning; conduct due diligence; devise a value creation plan (cost reductions, revenue enhancement, asset optimization); close the deal; implement governance and operational changes; and pursue an exit within a typical horizon of several years, commonly via sale to a strategic buyer or an initial public offering.

Risks and limitations include high leverage and interest-rate exposure, economic downturns, overpayment, and execution risk. Variants include management buyouts (MBOs) and management buy-ins (MBIs). Notable historical examples include large-scale LBOs in the late 20th century, such as the 1989 buyout of RJR Nabisco led by Kohlberg Kravis Roberts.