Leverage buyouts are used frequently in the United States. The concept is simple, but the execution is complex. Leverage buyouts are a financial transaction where a company or investor acquires another company by using a small amount of equity from the buyer, such as 10 percent of the acquiring price, and the balance of the purchase price is secured by the assets of the company being acquired. The company being acquired assumes the new (and often significant) debt.
How do Leverage Buyouts Work?
Leverage buyouts work in two ways. In a first way, a buyer purchases the assets of a company and those assets are placed in a new entity that will operate the business. The new company has limited liabilities from the old company’s operations, thus giving it a “fresh start.” In a second way, the buyer purchases the entire company by buying all its shares, giving the new entity total control of the business including its assets and liabilities.
Leveraged buyouts are attractive because the purchase of a company is “leveraged” by a small amount of owner’s equity. However, the acquired company now has a higher level of debt, thus increasing the risks of poor performance.
Why do Companies Do Leverage Buyouts?
Leverage buyouts can be used to take a public company private, to break up a larger company into smaller entities that may be more profitable or more attractive to future investors, to improve a struggling or underperforming company, or to enrich a company’s shareholders and owners.
How Are Leverage Buyouts Financed?
Smaller leverage buyouts can be financed using seller financing, conventional loans, SBA-backed loans, or with small investors. Mid-sized and larger leverage buyouts can be financed through senior debt, mezzanine, and subordinated debt, as well as seller financing.
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