What Is a Leveraged Buyout

A leveraged buyout is way to acquire a company using other people's money. In a leveraged buyout, the purchaser uses the target company's assets as collateral for the loan used to purchase the target company.

If it sounds like a hostile way to take over a company, it is, which is why it is considered a predatory business operation.

The purpose of a leveraged buyout is to be able to acquire control of a company without having to tie up a lot of capital in the purchase.

The acquiring company will also work to maximize shareholder value. It can be a risky venture, which is why share prices for a both companies tend to fall when a leveraged buyout is announced.

Identifying Company

Before a leveraged buyout begins, the acquirer must make sure that the target company can be acquired through a leveraged buyout.

This means making sure that the target company has sufficient assets to collateralize the loan needed to gain control of the company.

Then financial forecasts need to be made to ensure that the combination of the target company and the acquiring company will generate enough cash to make payments on the loan.

Leveraging Assets

If a leveraged buyout is feasible, then the acquiring company will work to have enough cash to gain control of the target company. This is done by borrowing the money through a loan.

A loan large enough to generate the needed cash would also need a substantial amount of collateral to make the risk worth it for a lender.

The acquiring company uses the target company's own assets to collateralize the loan. It doesn't need to be worth enough to purchase the entire company, only to acquire a controlling interest in the target company.

Making a Profit

The acquiring company will then control the target company for five to ten years, allowing some of the debt to be paid off and the target company to grow.

At that point, the acquiring company will either take the target company public or sell off its position in the company for a substantial profit. It is not uncommon for the annualized profit in a leveraged buyout to be in the 15 to 25 percent range.