Chapter 12
Leveraged buyout transactionsa
12.1 Introduction
A leveraged buyout (LBO) is the acquisition by a private equity (PE) fund of a company, business unit, or group of assets (the target) using debt to finance the majority of the purchase price and equity for the remainder. If the target is a public company, the private equity firm may pay a premium of 15% to 50% over the current stock price (e.g., see the academic evidence provided by Kaplan, 1989; Bargeron et al., 2008). LBO transactions take many different forms with varying levels of leverage, size, required returns, or other dimensions. This chapter aims to describe the “typical” LBO transaction.
The amount of debt used is typically around 65% to 70% of the target’s purchase price, but has reached around 90% on some deals during the peak transaction years—hence the term “leveraged buyout”. The LBO buyer (also known as the LBO sponsor) raises the debt through bonds and/or bank loans issued by the target company. The debt is either secured against the target’s assets or is unsecured, and the target’s free cash flows are used to service and repay the debt. The debt almost always includes a loan portion that is senior and secured, and is arranged by a bank or an investment bank. In the 1980s and 1990s, banks were also the primary investors in these loans. More recently, however, institutional investors have purchased a large fraction of senior and secured loans.1 The debt in leveraged buyouts also often includes a junior ...
