HOME

TheInfoList




A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money (
leverage Leverage or leveraged may refer to: *Leverage (mechanics), mechanical advantage achieved by using a lever *Leverage (album), ''Leverage'' (album), a 2012 album by Lyriel *Leverage (dance), a type of dance connection *Leverage (finance), using giv ...
) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the assets of the acquiring company. The use of debt, which normally has a lower
cost of capital In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societies. T ...
than equity, serves to reduce the overall cost of financing the acquisition. The cost of debt is lower because interest payments often reduce corporate income tax liability, whereas dividend payments normally do not. This reduced cost of financing allows greater gains to accrue to the equity, and, as a result, the debt serves as a lever to increase the returns to the equity. The term LBO is usually employed when a
financial sponsor A financial sponsor is a private-equity Private equity (PE) typically refers to investment funds, generally organized as limited partnerships, that buy and restructure companies that are not publicly traded. Private equity is a type of equity (f ...
acquires a company. However, many corporate transactions are partially funded by bank debt, thus effectively also representing an LBO. LBOs can have many different forms such as management buyout (MBO), management buy-in (MBI), secondary
buyout In finance, a buyout is an investment To invest is to allocate money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms ...
and tertiary buyout, among others, and can occur in growth situations, restructuring situations, and insolvencies. LBOs mostly occur in private companies, but can also be employed with public companies (in a so-called PtP transaction – public-to-private). As financial sponsors increase their returns by employing a very high leverage (i.e., a high ratio of debt to equity), they have an incentive to employ as much debt as possible to finance an acquisition. This has, in many cases, led to situations in which companies were "over-leveraged", meaning that they did not generate sufficient cash flows to service their debt, which in turn led to insolvency or to
debt-to-equity swap Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore accounting liquidity, liquidity so ...
s in which the equity owners lose control over the business to the lenders.


Characteristics

LBOs have become attractive as they usually represent a
win-win In game theory Game theory is the study of mathematical models of strategic interaction among Rational agent, rational decision-makers.Roger B. Myerson, Myerson, Roger B. (1991). ''Game Theory: Analysis of Conflict,'' Harvard University Press, ...
situation for the financial sponsor and the banks: the financial sponsor can increase the rate of returns on its equity by employing the leverage; banks can make substantially higher margins when supporting the financing of LBOs as compared to usual corporate
lending In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that debt ...
, because the interest chargeable is that much higher. Banks can increase their likelihood of being repaid by obtaining collateral or security. The amount of debt that banks are willing to provide to support an LBO varies greatly and depends, among other things, on the quality of the asset to be acquired, including its cash flows, history,
growth
growth
prospects, and
hard assetIn finance, a "hard asset" may be real estate, commodities, or energy.Assaf Razin, Understanding Global Crises: An Emerging Paradigm' (MIT Press, 2014), at 1.1. For example, Gold as an investment, gold and Silver as an investment, silver are regarded ...
s; experience and equity supplied by the financial sponsor; and the overall economic environment. Debt volumes of up to 100% of a purchase price have been provided to companies with very stable and secured cash flows, such as real estate portfolios with rental income secured by long-term rental agreements. Typically, debt of 40–60% of the purchase price may be offered. Debt ratios vary significantly among regions and target industries. Depending on the size and purchase price of the acquisition, the debt is provided in different tranches; senior debt is secured with the assets of the target company and has the lowest interest margins, and junior debt, or
mezzanine capital , Ottawa, Ontario, Canada Canada is a country in the northern part of North America. Its Provinces and territories of Canada, ten provinces and three territories extend from the Atlantic Ocean, Atlantic to the Pacific Ocean, Pacific and nor ...
, usually has no
security interest In finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...
s and thus bears higher interest margins. In larger transactions, sometimes all or part of these two debt types is replaced by
high yield bonds In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a Bond (finance), bond that is rated below investment grade. These bonds have a higher risk of default (finance), default or other adverse credit e ...
. Depending on the size of the acquisition, debt as well as equity can be provided by more than one party. In larger transactions, debt is often syndicated, meaning that the bank who arranges the credit sells all or part of the debt in pieces to other banks in an attempt to diversify and hence reduce its risk. Another form of debt that is used in LBOs are seller notes (or vendor loans) in which the seller effectively uses parts of the proceeds of the sale to grant a loan to the purchaser. Such seller notes are often employed in management buyouts or in situations with very restrictive bank financing environments. Note that in close to all cases of LBOs, the only collateralization available for the debt are the assets and cash flows of the company. The financial sponsor can treat their investment as common equity or preferred equity among other types of securities. Preferred equity can pay a dividend and has payment preferences to common equity. In addition to the amount of debt that can be used to fund leveraged buyouts, it is also important to understand the types of companies that
private equity Private equity (PE) typically refers to investment funds, generally organized as limited partnerships, that buy and restructure companies that are not publicly traded. Private equity is a type of equity and one of the asset classes consisti ...
firms look for when considering leveraged buyouts. While different firms pursue different strategies, there are some characteristics that hold true across many types of leveraged buyouts: * Stable cash flows – The company being acquired in a leveraged buyout must have sufficiently stable cash flows to pay its interest expense and repay debt principal over time. So mature companies with long-term customer contracts and/or relatively predictable cost structures are commonly acquired in LBOs. * Relatively low fixed costs – Fixed costs create substantial risk for private equity firms because companies still have to pay them even if their revenues decline. * Relatively little existing debt – The "math" in an LBO works because the private equity firm adds more debt to a company's capital structure, and then the company repays it over time, resulting in a lower effective purchase price; it's tougher to make a deal work when a company already has a high debt balance. * Valuation – Private equity firms prefer companies that are moderately undervalued to appropriately valued; they prefer not to acquire companies trading at extremely high valuation multiples (relative to the sector) because of the risk that valuations could decline. * Strong management team – Ideally, the
C-level Corporate titles or business titles are given to company and organization officials to show what duties and responsibilities they have in the organization. Such titles are used by publicly and privately held for-profit corporation A cor ...
executives will have worked together for a long time and will also have some vested interest in the LBO by rolling over their shares when the deal takes place.


History


Origins

The first leveraged buyout may have been the purchase by McLean Industries, Inc. of
Pan-Atlantic Steamship Company SeaLand, a division of the Maersk Group, is an American intra-regional container shipping company Freight companies are companies that specialize in the moving (or "Freight forwarding, forwarding") of freight, or cargo, from one place to anoth ...
in January 1955 and
Waterman Steamship Corporation Waterman Steamship Corporation is an American deep sea ocean carrier, specializing in liner services and time charter contracts. It is owned by International Shipholding Corporation, based in Mobile, Alabama. History Waterman was founded in 1919 ...
in May 1955. Under the terms of that transaction, McLean borrowed $42 million and raised an additional $7 million through an issue of
preferred stock Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital __NOTOC__ A corporation's share capital
. When the deal closed, $20 million of Waterman cash and assets were used to retire $20 million of the loan debt. Lewis Cullman's acquisition of Orkin Exterminating Company in 1964 is among the first significant leveraged buyout transactions. Similar to the approach employed in the McLean transaction, the use of
publicly traded A public company, publicly traded company, publicly held company, publicly listed company, or public limited company A public limited company (legally abbreviated to PLC or plc) is a type of public company under United Kingdom company law, som ...
holding companies as investment vehicles to acquire portfolios of investments in corporate assets was a relatively new trend in the 1960s, popularized by the likes of
Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may ...
(
Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may refer to: * Multinational corporation, a corporate organization operating in multiple countries * Multinational force, a military body from multiple countries * Multinational ...

Berkshire Hathaway
) and
Victor Posner Victor Posner (September 18, 1918 – February 11, 2002) was an American businessman. He was known as one of the highest-paid business executives of his generation. He was a pioneer of the leveraged buyout and became notorious for asset ...
( DWG Corporation), and later adopted by
Nelson Peltz Nelson Peltz (born June 24, 1942) is an American billionaire A billionaire is a person with a net worth of at least 1,000,000,000, one billion (1,000,000,000, i.e. a thousand million) units of a given currency, usually of a major currency such ...
(
Triarc The Wendy's Company is an American holding company A holding company is a company (law), company that owns the Shares outstanding, outstanding stock of other companies. A holding company usually does not produce goods or services itself. Its ...
),
Saul Steinberg Saul Steinberg (June 15, 1914 – May 12, 1999) was a Romanian American cartoonist A cartoonist (also comic strip creator, comic book artist, graphic novel artist, or comic book illustrator) is a visual artist who specializes in drawing ca ...
(Reliance Insurance) and
Gerry Schwartz Gerald W. Schwartz, OC (born 1941) is the founder, chairman and CEO of Onex Corporation Onex Corporation is an investment manager founded in 1984. The firm manages capital on behalf of Onex shareholders, institutional investors and high net wo ...
(
Onex Corporation Onex Corporation is an investment manager founded in 1984. The firm manages capital on behalf of Onex shareholders, institutional investors and high net worth clients around the world. As of December 31, 2020, Onex had approximately US$44 bill ...

Onex Corporation
). These investment vehicles would utilize a number of the same tactics and target the same type of companies as more traditional leveraged buyouts and in many ways could be considered a forerunner of the later private equity firms. In fact, it is Posner who is often credited with coining the term "leveraged buyout" or "LBO." The leveraged buyout boom of the 1980s was conceived in the 1960s by a number of corporate financiers, most notably Jerome Kohlberg, Jr. and later his protégé
Henry Kravis Henry R. Kravis (born January 6, 1944) is an American businessman, investor, and philanthropist.
. Working for
Bear Stearns The Bear Stearns Companies, Inc. was a New York-based global investment bank, security (finance), securities trading and brokerage firm that failed in 2008 as part of the Great Recession, global financial crisis and recession, and was subsequentl ...

Bear Stearns
at the time, Kohlberg and Kravis, along with Kravis' cousin
George Roberts
George Roberts
, began a series of what they described as "bootstrap" investments. Many of the target companies lacked a viable or attractive exit for their founders, as they were too small to be taken public and the founders were reluctant to sell out to competitors: thus, a sale to an outside buyer might prove attractive. In the following years, the three
Bear Stearns The Bear Stearns Companies, Inc. was a New York-based global investment bank, security (finance), securities trading and brokerage firm that failed in 2008 as part of the Great Recession, global financial crisis and recession, and was subsequentl ...

Bear Stearns
bankers would complete a series of buyouts including Stern Metals (1965), Incom (a division of Rockwood International, 1971), Cobblers Industries (1971), and Boren Clay (1973) as well as Thompson Wire, Eagle Motors and Barrows through their investment in Stern Metals. By 1976, tensions had built up between Bear Stearns and Kohlberg, Kravis and Roberts leading to their departure and the formation of
Kohlberg Kravis Roberts KKR & Co. Inc. (formerly known as Kohlberg Kravis Roberts & Co. and KKR & Co. L.P.) is an American global investment company An investment company is a financial institution principally engaged in investing in security (finance), securities. The ...
in that year.


1980s

In January 1982, former U.S.
Secretary of the Treasury The United States secretary of the treasury is the head of the United States Department of the Treasury, which is concerned with all financial and monetary matters relating to the federal government, and, until 2003, also included several major ...
William E. Simon and a group of investors acquired Gibson Greetings, a producer of greeting cards, for $80 million, of which only $1 million was rumored to have been contributed by the investors. By mid-1983, just sixteen months after the original deal, Gibson completed a $290 million IPO and Simon made approximately $66 million. The success of the Gibson Greetings investment attracted the attention of the wider media to the nascent boom in leveraged buyouts. Between 1979 and 1989, it was estimated that there were over 2,000 leveraged buyouts valued in excess of $250 billion. In the summer of 1984 the LBO was a target for virulent criticism by
Paul Volcker Paul Adolph Volcker Jr. (; September 5, 1927 – December 8, 2019) was an American economist. He served two terms as the 12th Chair of the Federal Reserve The chair of the Board of Governors of the Federal Reserve System is the head of the Fed ...
, then
chairman of the Federal Reserve The chair of the Board of Governors of the Federal Reserve System is the head of the Federal Reserve The Federal Reserve System (also known as the Federal Reserve or simply the Fed) is the central banking system of the United States of Ame ...
, by John S.R. Shad, chairman of the
U.S. Securities and Exchange Commission The U.S. Securities and Exchange Commission (SEC) is a large independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929 The Wall Street Crash of 1929, also known as the Great Crash ...
, and other senior financiers. The gist of all the denunciations was that top-heavy reversed pyramids of debt were being created and that they would soon crash, destroying assets and jobs. During the 1980s, constituencies within acquired companies and the media ascribed the "
corporate raid In business, a corporate raid is the process of buying a large stake in a corporation and then using shareholder voting rights to require the company to undertake novel measures designed to increase the share value, generally in opposition to the d ...
" label to many private equity investments, particularly those that featured a
hostile takeover In business, a takeover is the purchase of one company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, w ...
of the company, perceived
asset stripping Asset stripping is a term used to refer to the practice of selling off a company's assets in order to improve returns for equity investors. In many cases where the term is used, a financial investor, referred to as a 'corporate raider', takeover, ta ...
, major layoffs or other significant corporate restructuring activities. Among the most notable investors to be labeled corporate raiders in the 1980s included
Carl Icahn Carl Celian Icahn (; born February 16, 1936) is an American businessman. He is the founder and controlling shareholder of Icahn Enterprises, a diversified conglomerate holding company based in New York City, formerly known as American Real Esta ...
,
Victor Posner Victor Posner (September 18, 1918 – February 11, 2002) was an American businessman. He was known as one of the highest-paid business executives of his generation. He was a pioneer of the leveraged buyout and became notorious for asset ...
,
Nelson Peltz Nelson Peltz (born June 24, 1942) is an American billionaire A billionaire is a person with a net worth of at least 1,000,000,000, one billion (1,000,000,000, i.e. a thousand million) units of a given currency, usually of a major currency such ...
, Robert M. Bass, T. Boone Pickens, Harold Clark Simmons,
Kirk Kerkorian Kerkor "Kirk" Kerkorian (June 6, 1917 – June 15, 2015) was an American businessman, investor, and philanthropist. He was the president and CEO of Tracinda Corporation Tracinda Corporation is an American private investment corporation t ...

Kirk Kerkorian
,
Sir James Goldsmith Sir James Michael Goldsmith (26 February 1933 – 18 July 1997) was a French-British financier, tycoon A business magnate is someone who has achieved great success and enormous wealth through the ownership of multiple lines of enterprise. T ...
,
Saul Steinberg Saul Steinberg (June 15, 1914 – May 12, 1999) was a Romanian American cartoonist A cartoonist (also comic strip creator, comic book artist, graphic novel artist, or comic book illustrator) is a visual artist who specializes in drawing ca ...
and Asher Edelman.
Carl Icahn Carl Celian Icahn (; born February 16, 1936) is an American businessman. He is the founder and controlling shareholder of Icahn Enterprises, a diversified conglomerate holding company based in New York City, formerly known as American Real Esta ...
developed a reputation as a ruthless corporate raider after his hostile takeover of
TWA The Twa (also Batwa or Cwa) are a group of indigenous African Pygmy (Central African foragers) tribes. Overview Twa, also called Batwa, one of the best-known of the many Pygmy groups scattered across equatorial Africa. Like all other Af ...
in 1985.10 Questions for Carl Icahn
by Barbara Kiviat,
TIME magazine Time is the indefinite continued progress of existence and events that occur in an apparently irreversible succession from the past, through the present, into the future. It is a component quantity of various measurement ' Measurement is ...
, Feb. 15, 2007
Many of the corporate raiders were onetime clients of
Michael Milken Michael Robert Milken (born July 4, 1946) is an American formerly convicted felon, financier and philanthropist. He is noted for his role in the development of the market for high-yield bonds ("junk bonds"), and his conviction and sentence foll ...
, whose investment banking firm,
Drexel Burnham Lambert Drexel Burnham Lambert was an American investment bank that was forced into bankruptcy in 1990 due to its involvement in illegal activities in the junk bond market, driven by senior executive Michael Milken. At its height, it was a Bulge Brack ...
helped raise blind pools of capital with which corporate raiders could make a legitimate attempt to take over a company and provided
high-yield debt In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availab ...
financing of the buyouts. One of the final major buyouts of the 1980s proved to be its most ambitious and marked both a high-water mark and a sign of the beginning of the end of the boom that had begun nearly a decade earlier. In 1989, KKR closed in on a $31.1 billion takeover of
RJR Nabisco RJR Nabisco, Inc., was an American conglomerate Conglomerate or conglomeration may refer to: * Conglomerate (company) * Conglomerate (geology) * Conglomerate (mathematics) In popular culture: * The Conglomerate (American group), a production cre ...
. It was, at that time and for over 17 years following, the largest leveraged buyout in history. The event was chronicled in the book (and later the movie), '' Barbarians at the Gate: The Fall of RJR Nabisco''. KKR would eventually prevail in acquiring RJR Nabisco at $109 per share marking a dramatic increase from the original announcement that
Shearson Lehman Hutton Shearson was the name of a series of investment banking and retail brokerage firms from 1902 until 1994, named for Edward ShearsonShearson Lehman Hutton Shearson was the name of a series of investment banking and retail brokerage firms from 1902 until 1994, named for Edward ShearsonForstmann Little & Co. Many of the major banking players of the day, including
Morgan Stanley Morgan Stanley is an American multinational investment bank and financial services Financial services are the Service (economics), economic services provided by the finance industry, which encompasses a broad range of businesses that manage ...
,
Goldman Sachs The Goldman Sachs Group, Inc. () is an American multinational investment bank Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as tim ...

Goldman Sachs
,
Salomon Brothers Salomon Brothers, Inc., was an American multinational bulge bracket investment bank To invest is to allocate money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III a ...
, and
Merrill Lynch Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management Investment management is the professional asset management Asset management refers to a system ...
were actively involved in advising and financing the parties. After
Shearson Lehman Shearson was the name of a series of investment banking An investment bank is a financial services company or Corporate structure, corporate division that engages in advisory-based financial transactions on behalf of individuals, corporations, and ...
's original bid, KKR quickly introduced a tender offer to obtain RJR Nabisco for $90 per share – a price that enabled it to proceed without the approval of RJR Nabisco's management. RJR's management team, working with
Shearson Lehman Shearson was the name of a series of investment banking An investment bank is a financial services company or Corporate structure, corporate division that engages in advisory-based financial transactions on behalf of individuals, corporations, and ...
and
Salomon Brothers Salomon Brothers, Inc., was an American multinational bulge bracket investment bank To invest is to allocate money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III a ...
, submitted a bid of $112, a figure they felt certain would enable them to outflank any response by Kravis's team. KKR's final bid of $109, while a lower dollar figure, was ultimately accepted by the board of directors of RJR Nabisco. At $31.1 billion of transaction value, RJR Nabisco was the largest leveraged buyout in history until the 2007 buyout of
TXU Energy TXU Energy is an American retail electricity provider headquartered in Irving, Texas, serving residential and business customers in deregulated regions of Texas since the deregulation of the Texas electricity market in 2002. A subsidiary of Vis ...
by KKR and
Texas Pacific Group TPG Capital, previously known as Texas Pacific Group, is an American investment company An investment company is a financial institution principally engaged in investing in securities. These companies in the United States are regulated by the ...
. In 2006 and 2007, a number of leveraged buyout transactions were completed that for the first time surpassed the RJR Nabisco leveraged buyout in terms of nominal purchase price. However, adjusted for inflation, none of the leveraged buyouts of the 2006–2007 period surpassed RJR Nabisco. By the end of the 1980s the excesses of the buyout market were beginning to show, with the
bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' par ...

bankruptcy
of several large buyouts including
Robert Campeau Robert Joseph Antoine Campeau (August 3, 1923 June 12, 2017) was a Canadian Canadians (french: Canadiens) are people identified with the country of Canada. This connection may be residential, legal, historical or cultural. For most Canadian ...
's 1988 buyout of
Federated Department Stores Macy's, Inc. (originally Federated Department Stores, Inc.) is an American holding company A holding company is a company whose primary business is holding a controlling interest in the securities of other companies. A holding company usua ...
, the 1986 buyout of the
Revco Revco Discount Drug Stores (known simply as Revco or Revco, D.S.), once based in Twinsburg, Ohio Twinsburg is a suburban File:Husby Kista.jpg, The Swedish suburbs of Husby/Kista/Akalla are built according to the typical city planning of th ...
drug stores, Walter Industries, FEB Trucking and Eaton Leonard. Additionally, the RJR Nabisco deal was showing signs of strain, leading to a recapitalization in 1990 that involved the contribution of $1.7 billion of new equity from KKR.
Drexel Burnham Lambert Drexel Burnham Lambert was an American investment bank that was forced into bankruptcy in 1990 due to its involvement in illegal activities in the junk bond market, driven by senior executive Michael Milken. At its height, it was a Bulge Brack ...
was the
investment bank Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is a term for the management, creati ...
most responsible for the boom in private equity during the 1980s due to its leadership in the issuance of
high-yield debt In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availab ...
. Drexel reached an agreement with the government in which it pleaded ''
nolo contendere ' is a legal term that comes from the Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Latin was originally spoken in the area around Rome, known as Latium. Throug ...
'' (no contest) to six felonies – three counts of stock parking and three counts of
stock manipulation Market manipulation is a type of market abuse where there is a deliberate attempt to interfere with the free and fair operation of the market; the most blatant of cases involve creating false or misleading appearances with respect to the price of, ...
. It also agreed to pay a fine of $650 million – at the time, the largest fine ever levied under securities laws. Milken left the firm after his own indictment in March 1989. On February 13, 1990, after being advised by
United States Secretary of the Treasury The United States secretary of the treasury is the head of the United States Department of the Treasury The Department of the Treasury (USDT) is the national treasury A treasury is either *A government department related to finance and ta ...
Nicholas F. Brady, the
U.S. Securities and Exchange Commission The U.S. Securities and Exchange Commission (SEC) is a large independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929 The Wall Street Crash of 1929, also known as the Great Crash ...
(SEC), the
New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange A stock exchange, securities exchange, or bourse is an exchange Exchange may refer to: Places United States * Exchange, Indiana Exchange is an U ...

New York Stock Exchange
, and the
Federal Reserve The Federal Reserve System (also known as the Federal Reserve or simply the Fed) is the central bank A central bank, reserve bank, or monetary authority is an institution that manages the and of a or formal monetary union, and ove ...

Federal Reserve
,
Drexel Burnham Lambert Drexel Burnham Lambert was an American investment bank that was forced into bankruptcy in 1990 due to its involvement in illegal activities in the junk bond market, driven by senior executive Michael Milken. At its height, it was a Bulge Brack ...
officially filed for
Chapter 11 Chapter 11 of the United States Bankruptcy Code ( Title 11 of the United States Code The Code of Laws of the United States of America (variously abbreviated to Code of Laws of the United States, United States Code, U.S. Code, U.S.C., or USC) ...
bankruptcy protection.'' Den of Thieves''. Stewart, J. B. New York: Simon & Schuster, 1991. .


Age of the mega-buyout

The combination of decreasing interest rates, loosening lending standards, and regulatory changes for publicly traded companies (specifically the
Sarbanes–Oxley Act The Sarbanes–Oxley Act of 2002 is a that mandates certain practices in financial record keeping and reporting for corporations. The act, (), also known as the "Public Company Accounting Reform and Investor Protection Act" (in the ) and "Co ...
) would set the stage for the largest boom the private equity industry had seen. Marked by the buyout of
Dex Media Thryv is a publicly-traded software as a service company. It is headquartered in Dallas, Texas and operates in 48 states with more than 2,400 employees. The company began as a conglomerate of Yellow Pages companies. In June 2020, Thryv reported ...
in 2002, large multibillion-dollar U.S. buyouts could once again obtain significant high yield debt financing from various banks and larger transactions could be completed. By 2004 and 2005, major buyouts were once again becoming common, including the acquisitions of
Toys "R" Us Toys "R" Us is an American toy, clothing, and baby product retailer owned by Tru Kids, Tru Kids, Inc. (d.b.a. Tru Kids Brands) and various others. The company was founded in 1957; its first store was built in April 1948, with its headquarters ...
,
The Hertz Corporation The Hertz Corporation, a subsidiary of Hertz Global Holdings, Inc., is an American car rental company based in Estero, Florida, that operates 10,200 corporate and franchisee locations internationally. As the second-largest US car rental compan ...
,
Metro-Goldwyn-Mayer Metro-Goldwyn-Mayer Studios Inc. (also known as Metro-Goldwyn-Mayer Pictures or MGM) is an American media company, founded in 1924, that produces and distributes feature films and television programs. It is based in Beverly Hills, California ...
and
SunGard SunGard was an American multinational company based in Wayne, Pennsylvania, which provided software and services to education, financial services Financial services are the Service (economics), economic services provided by the finance industry ...
in 2005. As 2005 ended and 2006 began, new "largest buyout" records were set and surpassed several times with nine of the top ten buyouts at the end of 2007 having been announced in an 18-month window from the beginning of 2006 through the middle of 2007. In 2006, private equity firms bought 654 U.S. companies for $375 billion, representing 18 times the level of transactions closed in 2003. Additionally, U.S.-based private equity firms raised $215.4 billion in investor commitments to 322 funds, surpassing the previous record set in 2000 by 22% and 33% higher than the 2005 fundraising total The following year, despite the onset of turmoil in the credit markets in the summer, saw yet another record year of fundraising with $302 billion of investor commitments to 415 funds Among the mega-buyouts completed during the 2006 to 2007 boom were:
EQ Office EQ Office is a real estate investment Real estate investing involves the purchase, ownership, management, rental and/or sale of real estate Real estate is property consisting of land and the buildings on it, along with its natural resource ...
,
HCA HCA may refer to: Courts * High Court of Australia, the supreme court in the Australian court hierarchy and the final court of appeal in Australia Organizations Europe * Hall–Carpenter Archives, an archive of materials related to gay activism ...
,
Alliance Boots Alliance Boots GmbH was a multinational pharmacy-led health and beauty group with corporate headquarters in Bern, Switzerland ,german: Schweizer(in),french: Suisse(sse), it, svizzero/svizzera or , rm, Svizzer/Svizra , government_type = Feder ...
and TXU. In July 2007, turmoil that had been affecting the mortgage markets spilled over into the leveraged finance and
high-yield debt In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availab ...
markets. The markets had been highly robust during the first six months of 2007, with highly issuer friendly developments including PIK and PIK Toggle (interest is "''P''ayable ''I''n ''K''ind") and covenant light debt widely available to finance large leveraged buyouts. July and August saw a notable slowdown in issuance levels in the high yield and leveraged loan markets with only few issuers accessing the market. Uncertain market conditions led to a significant widening of yield spreads, which coupled with the typical summer slowdown led many companies and investment banks to put their plans to issue debt on hold until the autumn. However, the expected rebound in the market after
Labor Day Labor Day is a federal holiday in the United States In the United States, a federal holiday is a calendar date that is recognized and designated by the federal government of the United States as a holiday. Every year on a U.S. federal holid ...

Labor Day
2007 did not materialize and the lack of market confidence prevented deals from pricing. By the end of September, the full extent of the credit situation became obvious as major lenders including
Citigroup Citigroup Inc. or Citi (stylized File:Les Demoiselles d'Avignon.jpg, ''Les Demoiselles d'Avignon'' (1907), also by Picasso in a different style ("Picasso's African Period") four years later.In the visual arts, style is a "...distinctive mann ...

Citigroup
and
UBS AG UBS Group AG is a Swiss multinational investment bank Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In ...
announced major writedowns due to credit losses. The leveraged finance markets came to a near standstill. As 2007 ended and 2008 began, it was clear that lending standards had tightened and the era of "mega-buyouts" had come to an end. Nevertheless, private equity continues to be a large and active asset class and the private equity firms, with hundreds of billions of dollars of committed capital from investors are looking to deploy capital in new and different transactions.


Management buyouts

A special case of a leveraged acquisition is a management buyout (MBO). In an MBO, the incumbent management team (that usually has no or close to no shares in the company) acquires a sizeable portion of the shares of the company. Similar to an MBO is an MBI (Management Buy In) in which an external management team acquires the shares. An MBO can occur for a number of reasons; e.g., # Ownership wishes to retire and chooses to sell the company to trusted members of management # Ownership has lost faith in the future of the business and is willing to sell it to management (which believes in the future of the business) in order to retain some value for investment in the business # Management sees a value in the business that ownership does not see and does not wish to pursue In most situations, the management team does not have enough money to fund the equity needed for the acquisition (to be combined with bank debt to constitute the purchase price) so that management teams work together with financial sponsors to part-finance the acquisition. For the management team, the negotiation of the deal with the financial sponsor (i.e., who gets how many shares of the company) is a key value creation lever. Financial sponsors are often sympathetic to MBOs as in these cases they are assured that management believes in the future of the company and has an interest in value creation (as opposed to being solely employed by the company). There are no clear guidelines as to how big a share the management team must own after the acquisition in order to qualify as an MBO, as opposed to a normal leveraged buyout in which the management invests together with the financial sponsor. However, in the usual use of the term, an MBO is a situation in which the management team initiates and actively pushes the acquisition. MBO situations lead management teams often into a dilemma as they face a conflict of interest, being interested in a low purchase price personally while at the same time being employed by the owners who obviously have an interest in a high purchase price. Owners usually react to this situation by offering a deal fee to the management team if a certain price threshold is reached. Financial sponsors usually react to this again by offering to compensate the management team for a lost deal fee if the purchase price is low. Another mechanisms to handle this problem are earn-outs (purchase price being contingent on reaching certain future profitabilities). There probably are just as many successful MBOs as there are unsuccessful ones. Crucial for the management team at the beginning of the process is the negotiation of the purchase price and the deal structure (including the envy ratio) and the selection of the financial sponsor.


Secondary and tertiary buyouts

A secondary buyout is a form of leveraged buyout where both the buyer and the seller are private equity firms or financial sponsors (i.e., a leveraged buyout of a company that was acquired through a leveraged buyout). A secondary buyout will often provide a clean break for the selling private equity firms and its limited partner investors. Historically, given that secondary buyouts were perceived as distressed sales by both seller and buyer, limited partner investors considered them unattractive and largely avoided them. The increase in secondary buyout activity in 2000s was driven in large part by an increase in capital available for the leveraged buyouts. Often, selling private equity firms pursue a secondary buyout for a number of reasons: * Sales to strategic buyers and
IPOs In demonology Demonology is the study of demons or beliefs about demons, and the hierarchy of demons. They may be nonhuman, separable soul In many religious, philosophical, and myth Myth is a folklore genre consisting of narratives th ...
may not be possible for niche or undersized businesses. * Secondary buyouts may generate liquidity more quickly than other routes (i.e., IPOs). * Some kinds of businesses – e.g., those with relatively slow growth but which generate high cash flows – may be more appealing to private equity firms than they are to public stock investors or other corporations. Often, secondary buyouts have been successful if the investment has reached an age where it is necessary or desirable to sell rather than hold the investment further or where the investment had already generated significant value for the selling firm. Secondary buyouts differ from secondaries or secondary market purchases which typically involve the acquisition of portfolios of private equity assets including limited partnership stakes and direct investments in corporate securities. If a company that was acquired in a secondary buyout gets sold to another financial sponsor, the resulting transaction is called a tertiary buyout.


Failures

Some LBOs before 2000 have resulted in corporate bankruptcy, such as
Robert Campeau Robert Joseph Antoine Campeau (August 3, 1923 June 12, 2017) was a Canadian Canadians (french: Canadiens) are people identified with the country of Canada. This connection may be residential, legal, historical or cultural. For most Canadian ...
's 1988 buyout of
Federated Department Stores Macy's, Inc. (originally Federated Department Stores, Inc.) is an American holding company A holding company is a company whose primary business is holding a controlling interest in the securities of other companies. A holding company usua ...
and the 1986 buyout of the
Revco Revco Discount Drug Stores (known simply as Revco or Revco, D.S.), once based in Twinsburg, Ohio Twinsburg is a suburban File:Husby Kista.jpg, The Swedish suburbs of Husby/Kista/Akalla are built according to the typical city planning of th ...
drug stores. Many LBOs of the boom period 2005–2007 were also financed with too high a debt burden. The failure of the Federated buyout was a result of excessive debt financing, comprising about 97% of the total consideration, which led to large interest payments that exceeded the company's operating cash flow. Often, instead of declaring insolvency, the company negotiates a
debt restructuring Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress Financial distress is a term in corporate finance Corporate finance is the area of finance that dea ...
with its lenders. The financial restructuring might entail that the equity owners inject some more money in the company and the lenders waive parts of their claims. In other situations, the lenders inject new money and assume the equity of the company, with the present equity owners losing their shares and investment. The operations of the company are not affected by the financial restructuring. Nonetheless, the financial restructuring requires significant management attention and may lead to customers losing faith in the company. The inability to repay debt in an LBO can be caused by initial overpricing of the target firm and/or its assets. Over-optimistic forecasts of the revenues of the target company may also lead to
financial distress Financial distress is a term in corporate finance Corporate finance is the area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the fi ...
after acquisition. Some courts have found that in certain situations, LBO debt constitutes a fraudulent transfer under U.S. insolvency law if it is determined to be the cause of the acquired firm's failure. The outcome of litigation attacking a leveraged buyout as a fraudulent transfer will generally turn on the financial condition of the target at the time of the transaction – that is, whether the risk of failure was substantial and known at the time of the LBO, or whether subsequent unforeseeable events led to the failure. The analysis historically depended on "dueling" expert witnesses and was notoriously subjective, expensive, and unpredictable. However, courts are increasingly turning toward more objective, market-based measures. In addition, the Bankruptcy Code includes a so-called "safe harbor" provision, preventing bankruptcy trustees from recovering settlement payments to the bought-out shareholders. In 2009, the U.S. Court of Appeals for the Sixth Circuit held that such settlement payments could not be avoided, irrespective of whether they occurred in an LBO of a public or private company.QSI Holdings, Inc. v. Alford, --- F.3d ---, Case No. 08-1176 (6th Cir. July 6, 2009). To the extent that public shareholders are protected, insiders and secured lenders become the primary targets of fraudulent transfer actions. Banks have reacted to failed LBOs by requiring a lower debt-to-equity ratio, thus increasing the "skin in the game" for the financial sponsor and reducing the debt burden.


See also

*
Bootstrap funding Entrepreneurship is the creation or extraction of value. With this definition, entrepreneurship is viewed as change, generally entailing risk beyond what is normally encountered in starting a business, which may include other values than simply e ...
* Divisional buyout * Envy ratio * History of private equity and venture capital * List of private equity firms * Vulture capitalist


Notes


External links

*
LCD Loan Market Primer: LBOs – What are leveraged loans used for?

Investopedia definition – Leveraged Buyout
{{DEFAULTSORT:Leveraged Buyout Private equity