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What Is a Leveraged Buyout?

There are many factors, both personal and professional, that go into the decision to sell a small business. It's also not uncommon for a small business owner to hope that a new generation of management will step up to carry on the company's legacy. But when a potential buyer doesn't have a significant source of equity, a leveraged buyout is a possible option for acquisition.

Leveraged Buyouts Background

In a leveraged buyout, a buyer acquires a company by putting up only a small amount of money and borrowing the rest through a loan—as opposed to an entity using its own money or raising funds from its own investors. The buyer "leverages" its own equity to make a large purchase with a small amount of financing (ordinarily the ratio is about 90% debt to 10% equity). Typically, the assets of the company being acquired are offered as collateral. The expectation is that the acquired company will generate enough revenue to pay off the debt, resulting in high returns while risking only a small amount of capital. For this to work, typically the target company must be profitable, growing, and able to produce sufficient cash flow.

Leveraged buyouts have a somewhat turbulent history. They became popular in the 1980s when the high-yield junk bond market was available as financing for speculative-grade debt. However, several high profile corporate bankruptcies, the collapse of the junk bond market, and an increase in regulation of capital requirement rules all contributed to a cooling of the popularity of leveraged buyouts in the 1990s. There was a resurgence of interest in leveraged buyouts in the 2000s caused by a gain in popularity of private equity firms that raise capital from large institutional investors.

Reasons for Leveraged Buyouts

There are a variety of motivations for using leveraged buyouts to acquire a company. The most common three reasons for a leveraged buyout are:

  1. Taking a public company private
  2. Spinning-off a portion of the business
  3. Private transfers

 

Public to Private

A common use for leveraged buyouts is taking a publicly traded company private. This occurs when an investor or group uses leveraged loans to buy all outstanding stock and take a publicly traded company private. These sorts of buyouts can be either friendly or hostile. In this context, leveraged buyouts can be used as a particularly ruthless and predatory tactic whereby an outsider buys, reorganizes, and resells a company for a high return.

Spin-Off

Leveraged buyouts are also used when companies wish to "spin-off" and a portion of the existing business by selling it. This sometimes occurs when the seller itself has been bought through a leveraged buyout and is spinning off assets to repay the investors.

Private Transfers

Leveraged buyouts are also often used when a privately held organization is acquired by an investor group. This sometimes will occur when a small business owner reaches retirement age and either doesn't want to sell the company or can't find a corporate buyer. In this situation, often the company's employees or other people associated with the owner can buy the company through a leveraged buyout—even with limited equity.

Get Legal Help with Leveraged Buyouts

There are many options when selling or acquiring businesses. If you want to sell or buy a business and have questions about leveraged buyouts, speak with an experienced attorney to evaluate all options available to you.

Next Steps
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