Funding Post explains that a leveraged buyout is a transaction whereby one company acquires another, by buying out a significant portion of its equity using borrowed money. A leveraged buyout is also called a highly leveraged or bootstrap transaction. In this type of deal, the ratio of debt to equity is skewed very heavily towards the former. Often, the assets of the target company are used as collateral for the loan that needs to be taken in order to pay for the takeover. The loan in a leveraged buyout could be taken from a financing institution, or more often, raised from the public, by floating high yield bonds also known as junk bonds. Once the acquisition is complete, the target company might be made private, giving the new owners greater control. That's when they move into the kill, restructuring the company, literally taking it to pieces and selling parts of it to other buyers for huge profits.
Investors in a leveraged buyout have several options, including purchasing the bonds as mentioned above or buying equity through a specialized leveraged buyout fund. Although the large debt component increases risk to investors, it also holds the promise of significant returns at the time of exiting the investment.
The leveraged buyout concept has been around for over 40 years. It spent a couple of quiet decades, before really coming into its own in the 1980s. The tactic came in for a lot of flak, as it was perceived to destroy value and have a very disruptive effect. Naturally, it attracted the attention of the media as well as the regulatory authorities, and also forced vulnerable companies to reinforce themselves against the possibility of a hostile takeover. The “poison pill" or a tactic whereby target companies self-destruct in the event of a takeover was a direct reaction to the leveraged buyout. Talk of cutting off the nose to spite the face!
The spectacular rise of the leveraged buyout in the 1980s was shortlived, ironically undone by its own success. Everyone wanted a slice of the junk bond pie, and so much money was poured in that it pushed prices up and changed the buyout pricing and financing structure altogether. The leveraged buyout was officially dead when the stock markets were booming in the early 1990s, but seems to be resurrecting itself in a different form since the dotcom bust when sanity returned to valuations.
Experts believe that the buyout will make a comeback, as buyout firms are now faced with attractive options of taking over financially distressed companies, which have realistic expectations of valuation. However, they may not bring in the mind numbing returns of the glory days. A different strategy of deal making is in the offing. Leveraged buyout companies are more likely to target newer companies, with an entrepreneurial bent and technology intensity, as opposed to large companies in mature industries. The focus is also likely to move away from pure financial acumen to operational expertise. Acquirer companies are beginning to take a more active interest in the operations of the target company. And finally, the centre of the universe is shifting! More and more deals are happening outside of the United States, in Europe and Asia, as the industry turns global.
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