Role of Leveraged Buyout in M&A

A leveraged buyout, or LBO, is a specialized deal structure where a company is acquired through utilization of outside financing, from either a bank or another lender. Leveraged buyouts originally began back in the 1970’s. They increased in frequency throughout the 1980’s as a result of the advent of the junk bond market. The LBO market has continued to expand across many segments. The leveraged buyout market has expanded significantly for the large deal market as well as the middle market. Private equity funds pioneered the leveraged buyout as a deal structure and have been responsible for the large growth in the field. Leveraged buyouts began as financially driven projects wherein investors saw mispriced public companies whose value could be better monetized through going private. This led to many of the large LBO’s in the 1980’s including the signature deal of that era, the RJRNabisco deal pulled off byKKR. Over time, private equity firms have adopted less financially oriented and more strategic and operational oriented strategies when assessing LBO candidates. Many of the large, blue chip groups have management teams with industry expertise and best growth practices available to run their portfolio companies. Leveraged buyouts play an important role in M&A through being a mechanism of market equilibrium. If a company is underpriced relative to its growth potential, interest in acquiring the company through a leveraged buy out will arise. This will have a positive effect on the stock price of the company. In addition, LBO’s give aggressive entrepreneurs a way to buy companies and enter new industries without having to start a company from scratch. This gives entrepreneurs more ways to create value in the economy, thereby contributing to overall economic growth. Finally, the amount of M&A activity is largely driven by the number of leveraged buyouts. Any deal that uses a loan as part of its purchase price and involves purchasing a controlling interest is a leveraged buyout. The leveraged buyout has matured and has had a large contribution to the evolution of M&A market over the last 20 years.

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