Leverage buyouts have been used in business for many years. It is simply using borrowed money (debt) to facilitate the acquisition of one company by another. The use of debt to make the acquisition typically has a lower cost of capital than equity, so the cost of financing the acquisition is reduced. The assets of the company being acquired can be used as collateral for the acquisition.
How do Leverage Buyouts Take Place?
A company is acquired using a significant amount of debt. The acquiring company, or holding company, is often a private equity group that holds the acquired company for some time. Typically, after 3 to 7 years, the holding company sells the acquired company to achieve a substantial return on its invested capital. Leverage buyouts often push companies to reduce costs and improve profits. They also tend to give companies greater access to financing. Often, the acquiring company will have some advantageous management skills resulting in improved company performance.
Why do Businesses Use Leverage Buyouts?
Leverage buyouts are often used to acquire a competitor, to be able to enter new markets or diversify. Additionally, they may be used to make a public company private so that it can be “remodeled” and returned to the public market as a stronger entity. They can be used to break up a large company into more efficient companies that may be more attractive to potential investors. They can also be used to remake and improve a company that is struggling and underperforming.
What are the Characteristics of Good Leveraged Buyouts?
Good leveraged buyouts characteristics help provide a significantly positive return for the buying/investing company including having a predictable and steady cash flow, a solid potential for expense reduction, minimal capital requirements, a strong balance sheet, significant assets for loan collateral or divestiture, a strong market position, and a good exit strategy.
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