Essay On Leveraged Buyouts

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...

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...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.