Leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with 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.
A sizeable portion of the purchase price is financed by debt. The remaining sum is covered by equity contributions from the financial sponsor, and, in some situations, stock transfers made by the current management team of the business. The purchased company will have undergone a recapitalization and changed into a highly leveraged financial structure by the time the deal closes. Usually, the sponsor will keep the money for five to seven years. The acquired firm will use the cash flows it generates from its operations to cover the necessary interest payments and reduce some of the debt principal during the holding period. When evaluating an investment, the financial sponsor typically aims for an IRR of at least 20–25%.
