Essay On Leveraged Buyouts

2026 Words5 Pages
bulb-icon

Recommended: Disadvantage of a leverage buyout

Introduction
A leveraged buyout (LBO) is a common financial method of an acquisition of a public or private company funded with a significant amount by debts or loans (Hirt, Block, & Danielsen, 2011). The purpose of a leveraged buyout is to use the targeted firms’s cash to pay back the debt acquired to purchase the firm as soon as possible or in other words, leveraged buyouts allows companies to make large acquisitions without having to commit a lot of their capital (Leveraged Buyout-LBO, n.d.). With these external borrowings, buyers can grow the company and improve the performance of the company where the company can generate more cash to repay debt. Although there are many benefits of a leveraged buyout, there are risks involved as well.

Processes of Leveraged Buyouts
There are five steps of a leveraged buyout for any business (Basu, n.d.). The first step of a leveraged buyout is to prepare a short list of candidate companies. This step depends on the preference of investors as some investors look for under-performing companies where they can implement new management to turnover the company while some investors may only consider companies with strong management team. A strong company has the following criteria’s, which are good management team, high profit margins, strong cash flows, low debt levels, low capital expenditure requirements and a defensive of leading market niche. Strong companies as such can ensure the company to generate more cash and a good return for investments. (Whatley, n.d.). Companies with high fixed assets such as plant, property and equipment can act as loan collateral. Such companies have the alternative to sell surplus assets to pay for the debts acquired.
The second step of a leveraged buyout is to...

... middle of paper ...

...anagers to reduce their firm’s risk. In hope to help out firms, banks have reacted by requiring a lower debt-to-equity ratio and reducing the debt burden in hope to reduce LBOs failure.

Conclusion
In conclusion, leveraged buyout is a risky approach for companies as they are usually left with a huge debt obligation. However, if leveraged buyouts are managed properly and efficiently, it can generate rewarding returns for investors and benefit the targeted company as well. Using leveraged buyouts has it’s advantages where if it turns out well, it can help to develop and improve the economy as companies doing well can contribute to the growth of the economy. Although there are risks and disadvantages of leveraged buyouts, the advantages of it outweights the disadvantages. In order for companies to make a good rate of return, they have to take high risks or leverage.

Show More
Related

  • Target Corporation: Report On Long-Term Financing Policy And Capital Structure

    1647 Words  | 4 Pages

    This section will identify Target's proposed acquisition terms, price, financing, and potential negotiation strategies. This segment will also include price / earnings ratios, book value, current market value, and liquidation based on the supporting financial data. Also in this part will be a discussion of the general and specific risks inherent in an acquisition strategy. Background Information on Target According to www.targetcorp.com, Target is an upscale discount retail chain that sells quality products at attractive prices, and prides itself on clean, spacious, and guest-friendly stores.

    Read More

  • The Credit Crisis: Economic Downturn by Credit Squeeze, Provision of Doubtful Debt and Bankrupcies

    1088 Words  | 3 Pages

    ...nt interest. The company wanted to invest extra mortgage-backed securities with $100 million and get 7 percent interest. Then the company borrows a short term loan for $100 million at 4 percent interest. The leverage of company is $10 in a debt for every $1 of equity. The return on equity would be 3.7million on equity of $10million. Hence, investor was willing to obtain short term loan in the bank while they would be given a higher premium. Diamond and Rajan (2009) suggest that the short term debt is seemed like cheaper compared to the future illiquidity’s cost and the long term capital. Therefore, heavy short term leverage market becomes more common in the market of bank capital structure. While the risk-averse banker is unlikely bear the excessive risk, the illiquidity’s costs would be more salient. This had enforced the market into a heavy capital structure.

    Read More

  • MCI Case Analysis

    1816 Words  | 4 Pages

    Jen, F, Choi, D, and Lee, S. (1997). Some Evidence on Why Companies Use Convertible Bonds. Journal of Applied Corporate Finance. Retrieved on June 12, 2006 from the World Wide Web at: http://www.blackwell-synergy.com/links/doi/10.1111/j.1745-6622.1997.tb00124.x.

    Read More

  • The Merger of Two Competing Hospitals: A Case Study

    3362 Words  | 7 Pages

    Gaughan, P. A., 2002. Mergers, Acquisitions, and Corporate restructuring. 3rd ed.New York: John Wiley & Sons, Inc.

    Read More

  • Du Pont de Nemours and Company Case Analysis

    1186 Words  | 3 Pages

    In assessing Du Pont’s capital structure after the Conoco merger that significantly increased the company’s debt to equity ratio, an analyst must look at all benefits and drawbacks of a high debt ratio. The main reason why Du Pont ended up with a high debt to equity ratio after acquiring Conoco was due to the timing and price at which they bought Conoco. Du Pont ended up buying the firm at its peak, just before coal and oil prices started to fall and at a time when economic recession hurt the chemical industry of Du Pont. The additional response from analysts and Du Pont stockholders also forced Du Pont to think twice about their new expansion. The thought of bringing the debt ratio back to 25% was brought on by the fact that the company saw that high levels of capital spending were vital to the success of the firm and that high debt levels may put them at higher risk for defaulting.

    Read More

  • Critically assess the Pecking Order Theory of Capital Structure

    1779 Words  | 4 Pages

    There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than external financing which is due to adverse selection, asymmetry of information, and agency costs (Frank & Goyal, 2003). The trade-off theory comes from the pecking order theory it is an unintentional outcome of companies following the pecking-order theory. This explains that firms strive to achieve an optimal capital structure by using a mixture debt and equity known to act as an advantage leverage. Modigliani and Miller (1958) showed that the decisions firms make when choosing between debt and equity financing has no material effects on the value of the firm or on the cost or availability of capital. They assumed perfect and frictionless capital markets, in which financial innovation would quickly extinguish any deviation from their predicted equilibrium.

    Read More

  • Barbarians at the Gate

    335 Words  | 1 Pages

    Barbarians at the Gate is a story of the largest takeover in Wall Street history. Ross Johnson turned CEO of a company, which was the product of three merged companies, Standard Brands, RJ Reynolds, and National Biscuit Company (Nabisco). The newly formed company’s, called RJR Nabisco, stock began to fall and never recover. Johnson along with Shearson executives planned a leverage buyout (LBO), in which a brokerage firm (Shearson) would borrow money from banks and buy up all the outstanding shares from the stockholders to turn the company private. The problem with this is that the company would be put into jeopardy of other companies that can outbid the parent company, which would lead to a takeover. The higher the bid would lead to a bigger debt and lesser profits for the owners of the firm.

    Read More

  • Disneyland Hong Kong

    1681 Words  | 4 Pages

    only make up 16.7% of the capital structure. Thus, the credit risk for any credit commitment was not too high

    Read More

  • Leveraged Buyout Essay

    1754 Words  | 4 Pages

    The economy is always changing, and new ideas continue to be created, tested, and integrated into the financial world. Before World War II, wealthy families owned most companies and businesses. The families, or select wealthy individuals, dominated the economy and the rest of the population had little to no involvement in it. Takeovers, or buyouts of other companies were done in small scales, because the families lacked the funding to takeover larger companies. However, after the War the opportunities to participate in the economy slowly expanded. As the American communities began to recover, the economy slowly began to prosper once again. People began to invest more in companies, and buy shares in larger corporations, which allowed them to have some control over the management’s decisions. The old notion that companies were mostly family owned began to fade out; the owners were growing old and wanted to “avoid estate taxes and retain family control”. This left two options for them: either to make their family corporation in an initial public offering (IPO), or to have a larger company takeover. Neither of these options allowed the family to maintain complete control over their business. When Henry Kravis, Jerome Kohlberg, and George Roberts, began their careers in economics, they slowly began to utilize their own ideas and strategies, and eventually formed their own company. They reintroduced something called the leveraged buyout (LBO), a practice sparsely utilized by investors in the 1950’s, which later became the most popular form of takeover during the time. This buyout became the “third option” for the previously family owned companies to continue owning the business, but there were many other aspects included. These three...

    Read More

  • Cooper Industries Proposal to Acquire Nicholson File Company

    2708 Words  | 6 Pages

    Chang, S. Suk, D. Failed takeovers, methods of payment, and bidder returns, Financial Review. 33 (2), May 1998.

    Read More

  • UST Case Solution

    1327 Words  | 3 Pages

    Higher leverage is very likely to create value for a firm considering capital structure change by exerting financial discipline and more efficient corporate strategy changes.

    Read More

  • Internal Finance Essay

    1687 Words  | 4 Pages

    In our business world, ‘Capital is the lifeblood of every business venture’ (Smith, 2012). Capital can build up company, purchases non – current assets for instance machinery or plant and paid off daily expenses for examples wages, lighting, power etc. Every company needs to have someone to manage the finance by thinking different types finance which are internal short term, internal long term, external short term and external long term financial resources. These are the main four ways which can raise the capital but those sources may relate to different repayment rate and length and the amount will be received. When the owner and manager thinking to apply internal or external financial resources they need to consider Purpose, Amount, Repayment, Interest and Security which is name as PARIS. Purpose is identifying what type of finance are suitable to required, amount is how much should be borrow, repayment is how much and when should the business pay the finance back. Interest is how much is the finance cost and security is the business need put down the business assets or personal household as a deposit before receive any finance. These are the main concepts owner and manager need to remember before apply any type of finance. (Cox and Fardon, 2009) Director and manager need to think effectively for rising capital in an effective way which includes lower repayment and the control of the company. (Gillespie, 2001)

    Read More

  • Advantages And Disadvantages Of Capital Structure

    1186 Words  | 3 Pages

    The capital structure of a firm is the way in which it decides to finance its operations from various funds, comprising debt, such as bonds and outstanding loans, and equity, including stock and retained earnings. In the long term, firms seek to find the optimal debt-equity ratio. This essay will explore the advantages and disadvantages of different capital structure mixes, and consider whether this has any relevance to firm value in theory and in reality.

    Read More

  • Private Equity Importance

    864 Words  | 2 Pages

    stripping them off their assets and saddle them with debt, private equity firms build companies; they

    Read More

  • Essay On Debt Financing

    1066 Words  | 3 Pages

    Debt financing allows you purchase assets before you earn the necessary funds, which can be a great way to pursue an aggressive growth strategy (especially if you have access to low interest rates). Items like mining equipment, buildings, machines, equipment can all be obtained immediately once a loan is acquired. One of the advantages of debt financing is the ability to pay off your debt in installments over a period of time. Relative to equity financing, you also benefit by not relinquishing any ownership or control of the business. Finally, it is easy to forecast expenses because loan payments do not fluctuate.

    Read More

More about Essay On Leveraged Buyouts

Open Document