What is a Leveraged Buyout?

Hello from Spain and welcome to my brand new blog!

In my first post I want to talk about LBOs. I am pretty sure that if you work in finance you have listened about Private Equity, LBOs and all that stuff, but, What is an LBO?

Well, this is what Wikipedia says:

“A leveraged buyout (LBO) is a financial transaction in which a company is purchased with a combination of equity and debt, such that the company’s cash flow is the collateral used to secure and repay the borrowed money.”

But… what does it really means? In this post I will explain what is an LBO with a quite easy example to understand the concept, so… let’s go!

First of all, let’s imagine that we work in a Private Equity firm and we have a target Company that we want to buy with the following Balance Sheet:

As we can see, the value of the assets is equals to 700 M$ and this assets are composed by a value equals to 400 M$ in Equity and a value on Debt equals to 300 M$.

Now, we would create a Special Purpose Vehicle (SPV) to buy the Target Company. Let’s imagine that we want to buy the Company at a price equals to 1000 M$ with 200 M$ of Equity and 800 M$ of Debt. In this case we will have the Target’s Company Equity as a part of our Asset plus a GoodWill equals to 600 M$. I am pretty sure that the following image will make this idea more clear:

The next step to have the Structure of the LBO is doing a Merger between the Target Company and the SPV:

This would be the Balance Sheet after the merger:

And that’s it! The Structure of our LBO would be 1300 M$ in Assets with the GoodWill included, an Equity equals to 200 M$ and a total Debt equals to 1100 M$ composed by the Target’s Company Debt and the SPV Debt.

After finishing writing this post I would like talk about some important points in an LBO Structure.

1. This is the starting point, I mean, this is the structure that we will work with in order to forecast the P&L, Balance Sheet and Cash Flows before the exit.

2. As we can see, the final Balance Sheet has more amount of Debt that the initial one. The point is that we create value for the shareholders through the Debt.

3. We should have to take into account Coverage Ratios in the forecast in order to know if we would be able to pay the Debt in the future.

I hope you enjoy it!

See you son!



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