WHAT IS LEVERAGED BUYOUT?
- May 30, 2021
- Posted by: Marek Niedzwiedz, Your CFO
- Category: eCommerce Business Acquisition
A leveraged buyout (LBO) is the acquisition of a company, including an eCommerce business, division, or assets (Target) using debt to finance a large part of the purchase price. The remaining part is typically funded with an equity contribution by a financial sponsor – oftentimes private equity firms (Sponsor). Sponsors use LBOs to acquire control of a broad range of businesses, including both public and private. The sponsor’s ultimate goal is to realise an acceptable return on its equity investment upon exit, typically through a sale or IPO of the target. Sponsors usually seek a 15%-25% annualised return and an investment exit within 3-7 years.
In a traditional LBO, debt typically compromises 60%-70% of the financing structure, with equity compromising the remaining 30%-40%. The relatively high level of debt incurred by Target is supported by its projected free cash flow and asset base, enabling a Sponsor only to contribute a small equity investment relative to the purchase price. The ability to leverage the relatively small equity investment is essential for Sponsors to drive satisfactory returns. The use of leverage provides the additional benefit of tax savings realised due to the tax-deductibility of interest expense.
I personally did do or assisted in business acquisitions (LBOs, MBOs, or MBIs) where no equity was used by me/the buyer whatsoever. In such a situation, the equity may come from Target (the seller) and is then called seller/vendor’s finance.