What is leveraged buyout?

A leveraged buyout is when a firm buys another firm utilising a large amount of borrowed money in the form of bonds or loans to cover the purchase costs. A leveraged buyout typically has a debt-to-equity ratio of 90 percent debt to 10% equity. LBOs are carried out for three primary reasons:

  1. to convert a public corporation into a private one.
  2. to sell a section of an existing firm in order to spin it off.
  3. to transfer private property, such as in the case of a change of ownership of a small firm.

leveraged buyouts are acquisitions of companies (“buyouts”) with a fair amount of borrowed money (“leverage”).

An analogy would be buying an apartment for $1,000,000 with 80% debt and 20% equity with a view to rent it to a tenant. The rents received each month from the tenant would be used to service debt (ie pay interest and principal), and once the debt has been repaid in full, you would end up the happy owner of a debt-free $1,000,000 apartment, even though you only put up $200,000 of cash.