Leveraged Loans

A leveraged buyout (or LBO , or highly-leveraged transaction (HLT), or "bootstrap" transaction) occurs, when a financial sponsor acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage (borrowed money).

Firms of all sizes and industries may be the targets of a leveraged buyout, but because of the importance of debt and the ability of the acquired firm to make regular loan payments after the completion of a leveraged buyout, some features of potential target firms make for more attractive leverage buyout candidates, including:

• Low existing debt loads
• A multi-year history of consistent and reliable cash flows
• Hard assets (property, equipment, real-estate, inventory) that may be used as collateral for new debt
• The potential for new management to make operational or other improvements to the firm to boost cash flows
• Temporary market conditions that are depressing current valuation or stock price

As a percentage of the purchase price for a leverage buyout target, the amount of debt used to finance a transaction varies according to interest rates, the financial condition and history of the acquisition target, market conditions and the willingness of lenders to extend credit to the LBO's financial sponsors and the company to be acquired. Typically the debt portion of a LBO ranges from 50%-85% of the purchase price, but in some very rare cases debt may represent up to 95% of purchase price. Between 2000-2005 debt averaged between 59.4% and 67.9% of total purchase price for LBOs in the United States.

Leveraged buyouts allow financial sponsors to make large acquisitions without committing all the capital required for the acquisition. The use of debt also significantly increases the returns to a LBO's financial sponsor, as cash flows from the target company, rather than the financial sponsors, are used to pay down the debt used to purchase the company. This, in combination with the fact that financial sponsors pay only a portion of the original purchase price, means that a later sale of the company produces significant returns for the financial sponsor.

As transaction sizes grow, the equity component of the purchase price can be provided by multiple financial sponsors "co-investing" to come up with the needed equity for a purchase. Likewise, multiple lenders may band together in a "syndicate" to jointly provide the debt required to fund the transaction. Today, larger transactions are dominated by dedicated private equity firms and a limited number of large banks with "financial sponsors" groups.