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A leveraged buyout (LBO) is the acquisition of a company using a significant proportion of borrowed money ( leverage) to fund the acquisition with the remainder of the purchase price funded with
private equity Private equity (PE) is stock in a private company that does not offer stock to the general public; instead it is offered to specialized investment funds and limited partnerships that take an active role in the management and structuring of the co ...
. The assets of the acquired company are often used as collateral for the financing, along with any equity contributed by the acquiror. While corporate acquisitions often employ leverage to finance the purchase of the target, the term "leveraged buyout" is typically only employed when the acquiror is a
financial sponsor A financial sponsor is a private equity investment firm, particularly a private equity firm that engages in leveraged buyout transactions. Sponsors and management In addition to bringing capital to a deal, financial sponsors are expected to brin ...
(a
private equity Private equity (PE) is stock in a private company that does not offer stock to the general public; instead it is offered to specialized investment funds and limited partnerships that take an active role in the management and structuring of the co ...
investment firm). The use of debt, which normally has a lower
cost of capital In economics and accounting, the cost of capital is the cost of a company's funds (both debt and equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate ne ...
than equity, serves to reduce the overall cost of financing for the acquisition and enhance returns for the private equity investor. The equity investor can increase their projected returns by employing more leverage, creating incentives to maximize the proportion of debt relative to equity (i.e., debt-to-equity ratio). While the lenders have an incentive to limit the amount of leverage they will provide, in certain cases the acquired company may be "overleveraged", meaning that the amount of leverage assumed by the target company was too high for the cash flows generated by the company to service the debt. As a result, the increased use of leverage increases the risk of default should the company perform poorly after the buyout. Since the early 2000s, the debt-to-equity ratio in leveraged buyouts has declined significantly, resulting in increased focus on operational improvements and follow-on M&A activity to generate attractive returns.


Characteristics

left, 400px, Diagram of the basic structure of a generic leveraged buyout transaction A leveraged buyout is characterized by the extensive use of debt financing to acquire a company. This financing structure enables private equity firms and financial sponsors to control businesses while investing a relatively small portion of their own equity. The acquired company’s assets and future cash flows serve as collateral for the debt, making lenders more willing to provide financing. While different firms pursue different strategies, there are some characteristics that hold true across many types of leveraged buyouts: * High Debt-to-Equity Ratio: LBOs rely on a significant proportion of debt, typically ranging between 50% and 90% of the total purchase price. The remaining portion is financed through equity capital from the financial sponsor. * Stable and Predictable Cash Flows: Ideal LBO candidates generate consistent operating cash flows to meet debt obligations. Businesses with recurring revenue, high customer retention, and strong profit margins are prime targets. * Strong Asset Base for Collateral: Companies with tangible assets, such as real estate, inventory, and equipment, provide lenders with security, reducing credit risk. * Operational and Cost Efficiencies: Financial sponsors aim to improve profitability through cost-cutting measures, operational restructuring, and revenue growth strategies. * Tax Efficiency: Interest payments on LBO debt are typically tax-deductible, reducing the overall tax burden and improving post-tax cash flows. * Exit Strategy Focus: Private equity firms plan exit strategies before acquiring a company. Common exit options include an initial public offering (IPO), strategic sale, secondary buyout (SBO), or recapitalization. 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. Debt for an acquisition comes in two types: senior and junior. Senior debt is secured with the target company's assets and has lower interest rates. Junior debt has no security interests and higher interest rates. In big purchases, debt and equity can come from more than one party. Banks can also syndicate debt, meaning they sell pieces of the debt to other banks. Seller notes (or vendor loans) can also happen when the seller uses part of the sale to give the purchaser a loan. In LBOs, the only collateral is the company's assets and cash flows. The financial sponsor can treat their investment as common equity, preferred equity, or other securities. Preferred equity pays dividends and has priority over 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) is stock in a private company that does not offer stock to the general public; instead it is offered to specialized investment funds and limited partnerships that take an active role in the management and structuring of the co ...
firms look for when considering leveraged buyouts. Another key benefit to the equity investor in a leveraged buyout is the tax deductibility of interest payments on the acquisition financing which can offset the company's earnings and reduce the corporate income tax. Of course, the interest income on the interest payments are taxed at ordinary income rates rather than capital gains rates so while the allocation of taxes is shifted from the borrower to the lender, the total income tax generated from the company's earnings is often higher than it would be if less leverage were used.


Management buyouts

A "management buyout" (MBO) is a form of buyout in which the incumbent management team 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. Management buyouts are usually an indication of a high degree of conviction by management in the future prospects of the business relative to the existing ownership. Often, management is able to secure the company outside of an auction process allowing the management team to acquire the company on favorable terms. In many cases the management may still require additional equity from a financial sponsor, which may also be actively involved in securing the financing for the acquisition. Financial sponsors often find MBOs to be attractive situations as they have the opportunity to align itself with an insider who may have unique perspectives on the company and potential areas of operational improvement.


Secondary buyouts

A secondary buyout is the leveraged buyout of a company already owned by a private equity sponsor. A secondary buyout will often provide a realization event for the selling private equity owner(s) and its limited partner investors. Historically, given that private equity firms were extolling their unique ability to source attractive investments and drive value through a leveraged buyout, secondary buyouts were perceived as less attractive than the "primary buyout" of a private company or a "take-private" of a public company and were disdained by investors. Over time, it has been difficult to distinguish a differential investment returns based on the prior owner of the company and secondary buyouts have become a common part of the private equity ecosystem typically representing 25% to 35% of all leverage buyouts. For sellers, secondary buyouts have led to faster realizations than an
initial public offering An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also to retail (individual) investors. An IPO is typically underwritten by one or more investm ...
which often takes months to prepare and requires years after the IPO to realize the remaining public shares. Similarly the sale to another private equity sponsor may be less complex than the sale to a strategic corporate acquiror which could face regulatory scrutiny or challenges financing the purchase. Secondary buyouts differ from secondaries which typically involve the acquisition of portfolios of private equity assets including limited partnership stakes and direct investments in corporate securities. More recently GP-led Secondaries, in which a private equity sponsor creates a "continuation fund" to acquire a company from one of its own funds has brought together elements of secondary buyouts and management buyouts.


History


Origins

The first leveraged buyout may have been the purchase by McLean Industries, Inc. of Pan-Atlantic Steamship Company in January 1955 and
Waterman Steamship Corporation Waterman is an American deep sea ocean carrier, specializing in liner services and time charter contracts. It is owned by SEACOR Holdings. History Waterman was founded in 1919 in Mobile, Alabama by John Barnett Waterman, Henry Crawford Slaton, ...
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 that may have any combination of features not possessed by common stock, including properties of both an equity and a debt ins ...
. 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 is a company whose ownership is organized via shares of share capital, stock which are intended to be freely traded on a stock exchange or in over-the-counter (finance), over-the-counter markets. A public (publicly traded) co ...
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 investor and philanthropist who currently serves as the chairman and CEO of the conglomerate holding company Berkshire Hathaway. As a result of his investment success, Buffett is ...
(
Berkshire Hathaway Berkshire Hathaway Inc. () is an American multinational conglomerate holding company headquartered in Omaha, Nebraska. Originally a textile manufacturer, the company transitioned into a conglomerate starting in 1965 under the management of c ...
) and
Victor Posner Victor Posner (September 18, 1918 – February 11, 2002) was an American businessman. He was one of the highest-paid business executives of his generation. He was a pioneer of the leveraged buyout and became notorious for asset strippin ...
( DWG Corporation), and later adopted by
Nelson Peltz Nelson Peltz (born June 24, 1942) is an American billionaire businessman and investor. He is a founding partner, together with Peter W. May and Edward P. Garden, of Trian Partners, an alternative investment management fund based in New York. He i ...
(
Triarc The Wendy's Company is an American fast food corporation and the holding company for Wendy's and First Kitchen. Originally founded as the Deisel-Wemmer Company, it is sourced in Dublin, Ohio. The company's principal subsidiary, Wendy's Interna ...
),
Saul Steinberg Saul Steinberg (June 15, 1914, Rm. Sărat, Romania â€“ May 12, 1999, New York City) was a Romanian-born American artist, best known for his work for ''The New Yorker'', most notably ''View of the World from 9th Avenue''. He described himself ...
(Reliance Insurance) and
Gerry Schwartz Gerald W. Schwartz, OC (born 1941) is the founder and chairman of Onex Corporation. Schwartz has a net worth of US$1.5 billion, according to ''Forbes'' magazine. Early life and career Schwartz was born in Winnipeg, Manitoba. He graduated from ...
(
Onex Corporation Onex Corporation is a Canadian investment management firm founded by Gerry Schwartz in 1984. In September 2024, it had $50 billion dollars under management. History Schwartz founded Onex in 1984 and took the company public in 1987. In Jun ...
). 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. Jerome Kohlberg Jr. (July 10, 1925 – July 30, 2015) was an American businessman and investor. He was an early pioneer in the private equity and leveraged buyout industries founding private equity firm Kohlberg Kravis Roberts & Co. and later K ...
and later his protégé
Henry Kravis Henry Roberts Kravis (born January 6, 1944) is an American businessman, investor, and philanthropist.Bear Stearns The Bear Stearns Companies, Inc. was an American investment bank, securities trading, and brokerage firm that failed in 2008 during the 2008 financial crisis and the Great Recession. After its closure it was subsequently sold to JPMorgan Chas ...
at the time, Kohlberg and Kravis, along with Kravis' cousin 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 an American investment bank, securities trading, and brokerage firm that failed in 2008 during the 2008 financial crisis and the Great Recession. After its closure it was subsequently sold to JPMorgan Chas ...
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., also known as Kohlberg Kravis Roberts & Co., is an American global private-equity and investment company. , the firm had completed private-equity investments in portfolio companies with approximately $710 billion of total ...
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, and is the chief financial officer of the federal government of the United States. The secretary of the treasury serves as the principal a ...
William E. Simon William Edward Simon (November 27, 1927 – June 3, 2000) was an American businessman and philanthropist who served as the 63rd United States Secretary of the Treasury. He became the Secretary of the Treasury on May 9, 1974, during the Nixon adm ...
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 1980 and 1990, there were 180 leveraged buyouts involving firms with an aggregate book value of $39.2 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 who served as the 12th chair of the Federal Reserve, chairman of the Federal Reserve from 1979 to 1987. During his tenure as chairman, Volcker was widely ...
, 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, and is the active executive officer of the Board of Governors of the Federal Reserve System. The chairman presides at meetings of the Board. ...
, by John S.R. Shad, chairman of the
U.S. Securities and Exchange Commission The United States Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street crash of 1929. Its primary purpose is to enforce laws against market m ...
, 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 t ...
" label to many private equity investments, particularly those that featured a
hostile takeover In business, a takeover is the purchase of one company (law), company (the ''target'') by another (the ''acquirer'' or ''bidder''). In the UK, the term refers to the acquisition of a public company whose shares are publicly listed, in contrast t ...
of the company, perceived
asset stripping Asset stripping refers to selling off a company's assets to improve returns for equity investors, often a financial investor, a "corporate raider", who takes over another company and then auctions off the acquired company's assets. The term is ge ...
, 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 and investor. He is the founder and controlling shareholder of Icahn Enterprises, a public company and diversified conglomerate holding company based in Sunny Isles Beach, ...
,
Victor Posner Victor Posner (September 18, 1918 – February 11, 2002) was an American businessman. He was one of the highest-paid business executives of his generation. He was a pioneer of the leveraged buyout and became notorious for asset strippin ...
,
Nelson Peltz Nelson Peltz (born June 24, 1942) is an American billionaire businessman and investor. He is a founding partner, together with Peter W. May and Edward P. Garden, of Trian Partners, an alternative investment management fund based in New York. He i ...
,
Robert M. Bass Robert Muse Bass (born 19 March 1948) is an American billionaire businessman and philanthropist. He was the chairman of Aerion Corporation, an American aerospace firm in Reno, Nevada. In 2018, he had a net worth of $5 billion. Bass has served o ...
,
T. Boone Pickens Thomas Boone Pickens Jr. (May 22, 1928 â€“ September 11, 2019) was an American business magnate and financier. Pickens chaired the hedge fund BP Capital Management. He was a well-known takeover operator and corporate raider during the 1980 ...
,
Harold Clark Simmons Harold Clark Simmons (May 13, 1931 – December 29, 2013) was an American businessman, investor, and philanthropist whose banking expertise helped him develop the acquisition concept known as the leveraged buyout (LBO) to acquire various corpora ...
,
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, his private holding company based in Beverly Hills, California. Kerkorian ...
,
Sir James Goldsmith Sir James Michael Goldsmith (26 February 1933 – 18 July 1997) was a French-British financier and politician who was a member of the Goldsmith family. His controversial business and finance career led to ongoing clashes with British media, fr ...
,
Saul Steinberg Saul Steinberg (June 15, 1914, Rm. Sărat, Romania â€“ May 12, 1999, New York City) was a Romanian-born American artist, best known for his work for ''The New Yorker'', most notably ''View of the World from 9th Avenue''. He described himself ...
and
Asher Edelman Asher Barry Edelman (born November 26, 1939) is an American financier. Biography Edelman was the son of New York real estate investor, Richard M. Edelman. He graduated from Bard College and in 1961, he went to work for Halle and Stieglitz wh ...
.
Carl Icahn Carl Celian Icahn (; born February 16, 1936) is an American businessman and investor. He is the founder and controlling shareholder of Icahn Enterprises, a public company and diversified conglomerate holding company based in Sunny Isles Beach, ...
developed a reputation as a ruthless corporate raider after his hostile takeover of
TWA The Twa, often referred to as Batwa or Mutwa (singular), are indigenous hunter-gatherer peoples of the Great Lakes Region in Central Africa, recognized as some of the earliest inhabitants of the area. Historically and academically, the term †...
in 1985. Many of the corporate raiders were onetime clients of
Michael Milken Michael Robert Milken (born July 4, 1946) is an American financier. He is known for his role in the development of the market for High-yield debt, high-yield bonds ("junk bonds"), and his conviction and sentence following a guilty plea on felony ...
, whose investment banking firm,
Drexel Burnham Lambert Drexel Burnham Lambert Inc. was an American multinational 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, i ...
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, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit even ...
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 KKR may refer to: * KKR & Co., a global investment firm *Kolkata Knight Riders, an Indian Premier League franchise * Rheinsberg Nuclear Power Plant (), first nuclear power plant in the former East Germany * Kalkara, Malta, postal code KKR *Kir-Bala ...
closed in on a $31.1 billion takeover of
RJR Nabisco R. J. Reynolds Nabisco, Inc., doing business as RJR Nabisco, was an American conglomerate, selling tobacco and food products, headquartered in the Calyon Building in Midtown Manhattan, New York City. R. J. Reynolds Nabisco stopped ...
. 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 company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in 42 countries and more than 80,000 employees, the firm's clients in ...
,
Goldman Sachs The Goldman Sachs Group, Inc. ( ) is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered in Lower Manhattan in New York City, with regional headquarters in many internationa ...
,
Salomon Brothers Salomon Brothers, Inc., was an American multinational bulge bracket investment bank headquartered in New York City. It was one of the five List of investment banks, largest investment banking enterprises in the United States and a very profitabl ...
, and
Merrill Lynch Merrill Lynch, Pierce, Fenner & Smith Incorporated, doing business as Merrill, and previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investm ...
were actively involved in advising and financing the parties. After
Shearson Lehman Shearson was the name of a series of investment banking and retail brokerage firms from 1902 until 1994, named for Edward Shearson
, 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 Vist ...
by KKR and
Texas Pacific Group TPG Inc., previously known as Texas Pacific Group and TPG Capital, is an American private equity firm based in Fort Worth, Texas. TPG manages investment funds in growth capital, venture capital, public equity, and debt investments. The firm in ...
. 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 creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the deb ...
of several large buyouts including
Robert Campeau Robert Joseph Antoine Campeau (August 3, 1923 June 12, 2017) was a Canadian financier and real estate developer. Starting from a single house constructed in 1940 in the Alta Vista neighbourhood of Ottawa, Ontario, Campeau built a large land dev ...
's 1988 buyout of
Federated Department Stores Macy's, Inc. (previously Federated Department Stores, Inc.) is an American holding company of department stores. Upon its establishment in 1929, Federated held ownership of the regional department store chains Abraham & Straus, Lazarus (departm ...
, the 1986 buyout of the
Revco Revco Discount Drug Stores (known simply as Revco or Revco, D.S.), once based in Twinsburg, Ohio, was a major drug store chain operating through the Ohio Valley, the Mid-Atlantic states, and the Southeastern United States. The chain's stock w ...
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 Inc. was an American multinational 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, i ...
was the
investment bank Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...
most responsible for the boom in private equity during the 1980s due to its leadership in the issuance of
high-yield debt In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit even ...
. Drexel reached an agreement with the government in which it pleaded ''
nolo contendere ''Nolo contendere'' () is a type of legal plea used in some jurisdictions in the United States. It is also referred to as a plea of no contest or no defense. It is a plea where the defendant neither admits nor disputes a Criminal charge, charg ...
'' (no contest) to six felonies – three counts of stock parking and three counts of
stock manipulation In economics and finance, market manipulation occurs when someone intentionally alters the supply or demand of a security to influence its price. This can involve spreading misleading information, executing misleading trades, or manipulating ...
. 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, and is the chief financial officer of the federal government of the United States. The secretary of the treasury serves as the principal a ...
Nicholas F. Brady, the
U.S. Securities and Exchange Commission The United States Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street crash of 1929. Its primary purpose is to enforce laws against market m ...
(SEC), the
New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District, Manhattan, Financial District of Lower Manhattan in New York City. It is the List of stock exchanges, largest stock excha ...
, and the
Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of ...
,
Drexel Burnham Lambert Drexel Burnham Lambert Inc. was an American multinational 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, i ...
officially filed for
Chapter 11 Chapter 11 of the United States Bankruptcy Code ( Title 11 of the United States Code) permits reorganization under the bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every business, w ...
bankruptcy protection..


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 United States federal law that mandates certain practices in financial record keeping and reporting for corporations. The act, , also known as the "Public Company Accounting Reform and Investor Protectio ...
) would set the stage for the largest boom the private equity industry had seen. Marked by the buyout of
Dex Media Thryv Holdings, Inc. is a publicly traded software as a service (SaaS) company, providing customer relationship management and online reputation management software for small businesses. It has headquarters in Dallas, Texas, and operates in 48 ...
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 (doing business as Tru Kids Brands) and various others. The company was founded in 1948 in Washington, D.C.; its first store was built in April 1948, with i ...
,
The Hertz Corporation Hertz Global Holdings, Inc. (formerly The Hertz Corporation), known as Hertz, is an American car rental company based in Estero, Florida. The company operates its namesake Hertz brand, along with the brands Dollar Rent A Car, Firefly Car Re ...
,
Metro-Goldwyn-Mayer Metro-Goldwyn-Mayer Studios Inc. (also known as Metro-Goldwyn-Mayer Pictures, commonly shortened to MGM or MGM Studios) is an American Film production, film and television production and film distribution, distribution company headquartered ...
and
SunGard SunGard was an American multinational company based in Wayne, Pennsylvania, which provided software and services to education, financial services, and public sector organizations. It was formed in 1983, as a spin-off of the computer services di ...
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 company that owns 80 office properties comprising 40 million square feet. The company is owned by and funds managed by The Blackstone Group. The company was formerly known as Equity Office. History The compa ...
, HCA,
Alliance Boots Alliance Boots was a multinational pharmacy-led health and beauty group with corporate headquarters in Bern, Switzerland and operational headquarters in Nottingham and Weybridge, United Kingdom. The company had a presence in over 27 countries ...
and TXU. In July 2007, turmoil that had been affecting the mortgage markets spilled over into the
leveraged finance A leveraged buyout (LBO) is the acquisition of a company using a significant proportion of borrowed money ( leverage) to fund the acquisition with the remainder of the purchase price funded with private equity. The assets of the acquired company ...
and
high-yield debt In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit even ...
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 holidays in the United States, federal holiday in the United States celebrated on the first Monday of September to honor and recognize the Labor history of the United States, American labor movement and the works and con ...
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 (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services company based in New York City. The company was formed in 1998 by the merger of Citicorp, t ...
and
UBS AG UBS Group AG (stylized simply as UBS) is a multinational Investment banking, investment bank and financial services firm founded and based in Switzerland, with headquarters in both Zurich and Basel. It holds a strong foothold in all major fina ...
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.


Failures

As with all companies, a proportion of companies acquired in leveraged buyouts will experience financial challenges and given the higher debt-to-equity ratio of LBO targets, these financial challenges can result in default. Especially in the leveraged buyouts of the 1980s in which debt-to-equity ratios often exceeded 9 to 1, defaults occurred at notable levels.
Robert Campeau Robert Joseph Antoine Campeau (August 3, 1923 June 12, 2017) was a Canadian financier and real estate developer. Starting from a single house constructed in 1940 in the Alta Vista neighbourhood of Ottawa, Ontario, Campeau built a large land dev ...
's 1988 buyout of
Federated Department Stores Macy's, Inc. (previously Federated Department Stores, Inc.) is an American holding company of department stores. Upon its establishment in 1929, Federated held ownership of the regional department store chains Abraham & Straus, Lazarus (departm ...
and the 1986 buyout of the
Revco Revco Discount Drug Stores (known simply as Revco or Revco, D.S.), once based in Twinsburg, Ohio, was a major drug store chain operating through the Ohio Valley, the Mid-Atlantic states, and the Southeastern United States. The chain's stock w ...
drug stores were well documented failures that resulted in bankruptcy. 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. Many LBOs of the boom period 2005–2007 were also financed with too high a debt burden, however default rates were significantly below the expectations of market observers given the proximate onset of the
2008 financial crisis The 2008 financial crisis, also known as the global financial crisis (GFC), was a major worldwide financial crisis centered in the United States. The causes of the 2008 crisis included excessive speculation on housing values by both homeowners ...
. 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 used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy. Financial dist ...
after acquisition. Some courts have found that in certain situations, LBO debt constitutes a
fraudulent transfer A fraudulent conveyance or fraudulent transfer is the transfer of property to another party to prevent, hinder, or delay the collection of a debt owed by or incumbent on the party making the transfer, sometimes by rendering the transferring part ...
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 and it was rare that such findings were sustained. 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 The United States Court of Appeals for the Sixth Circuit (in case citations, 6th Cir.) is a federal court with appellate jurisdiction over the district courts in the following districts: * Eastern District of Kentucky * Western District of K ...
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. In certain cases, 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 to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continu ...
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.


See also

*
Bootstrap funding Entrepreneurship is the creation or extraction of economic value in ways that generally entail beyond the minimal amount of risk (assumed by a traditional business), and potentially involving values besides simply economic ones. An entrepreneu ...
*
Divisional buyout A divisional buyout or carveout, in finance, is a transaction in which a corporate division, business unit, or subsidiary is acquired using the same financial structuring as a leveraged buyout. Typically, in these transactions, the financial s ...
*
Envy ratio Envy ratio, in finance, is the ratio of the price paid by investors to that paid by the management team for their respective shares of the equity. Overview The ratio is used to consider an opportunity for a management buyout. Managers are often ...
*
History of private equity and venture capital The history of private equity, venture capital, and the development of these asset classes has occurred through a series of boom-and-bust cycles since the middle of the 20th century. Within the broader private equity industry, two distinct sub-in ...
*
List of private equity firms Below is a list of notable private equity firms. Largest private equity firms by PE capital raised Each year Private Equity International publishes the PEI 300, a ranking of the largest private-equity firms by how much capital they have raised fo ...
* 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 Corporate development Management cybernetics Mergers and acquisitions