Leveraged buyout is a generic phrase to refer to the use of “leverage” to buy out a business. The acquirer may be a private equity firm, another company in the industry or current management. Leveraged buyouts occur for either strategic reasons, financial reasons or a combination of the two. It is a time tested way for companies to build corporate value over an accelerated time frame. Private equity firms are the originators of the leveraged buyout structure and have been successfully deploying it since the 1970’s. In addition to using leverage to finance the buyout, private equity firms bring management focus, discipline and innovative growth ideas to their newly acquired companies. This often has the positive effect of accelerating growth, creating more jobs, and creating new and valuable products and markets.
A private equity firm, or PE firm, is the usual initiator of a buyout transaction whereby they buy a stake of a company to take it private or to change its strategic direction. This is distinct from venture capital firms that typically invest in only young, emerging companies and do not have majority control. Private equity firms combine concentrated ownership stakes with high-powered incentives to create a new, lean and efficient organization with minimal overhead costs. The private equity firms see the potential growth and long-term development of the company. The usually invest in a platform company to start. They usually then augment the platform company with a stream of add on acquisitions to expand regionally, product wise, and customer segment wise.
There are a series of steps that a private equity firm goes through before making an acquisition. First, the PE firm screens the LBO candidate by analyzing the company’s hard assets, cash flows, and capital expenditures. If the PE firm believes there is a deal, it negotiates a price and creates a deal structure and sources the capital. This capital is used to take control of the business and then allow the PE firm to make the strategic changes necessary to cut costs and increase revenue. If the price is right, the deal well-structured and the corporate growth occurs, the private equity firm targets an exits within 3 to 5 years.