1.1·7 min read

Buying with Borrowed Money

A leveraged buyout funds an acquisition mostly with debt and a smaller slice of equity. The target's own cash flows repay the debt.

By the end you can

✓Define a leveraged buyout
✓Explain how leverage amplifies equity returns

Leveraged buyout (LBO)

An acquisition funded with a large amount of debt and a smaller amount of equity from a (a private equity firm). The acquired company's own cash flows service and repay the debt.

Leverage is an amplifier

Because equity is a thin slice of the purchase, a modest rise in the company's value translates into a large percentage gain on that equity - and a modest fall can wipe it out. magnifies both directions.

Worked example · The same deal, with and without debt

Given

•Buy a company for an enterprise value of $1,000.
•Levered: $700 debt + $300 equity. After 5 years, EV is $1,200 and debt has been paid down to $400.
•All-equity buyer instead pays the full $1,000.

Solution

1.Levered exit equity
$1{,}200 - 400 = 800$
2.Levered return
$800 / 300 \approx 2.7\times$
3.All-equity return
$1{,}200 / 1{,}000 = 1.2\times$

Answer

A 20% rise in enterprise value became a ~167% gain on the 's equity - that gap is plus debt paydown at work.

Check yourself

Why can an LBO produce a high equity return from a modest rise in company value?

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The Players and the Logic