Editing Leveraged buyout (section)

== Characteristics ==
[[file:Leveraged Buyout Diagram.png|thumb|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.<ref name=InvestopediaLBO />

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.<ref name=McKinsey />
* 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.<ref name=HBR />
* Strong Asset Base for Collateral: Companies with tangible assets, such as real estate, inventory, and equipment, provide lenders with security, reducing credit risk.<ref name=SPCreditRisk />
* Operational and Cost Efficiencies: Financial sponsors aim to improve profitability through cost-cutting measures, operational restructuring, and revenue growth strategies.<ref>{{cite web |author=Bain & Company |title=Global Private Equity Report |url=https://www.bain.com/insights/topics/private-equity/ |website=Bain & Company |publisher=Bain & Company |access-date=}}</ref>
* Tax Efficiency: Interest payments on LBO debt are typically tax-deductible, reducing the overall tax burden and improving post-tax cash flows.<ref name=CFIModel>{{cite web |author=Corporate Finance Institute |title=Leveraged Buyout (LBO) Model |url=https://corporatefinanceinstitute.com/resources/knowledge/finance/leveraged-buyout-lbo-model/ |website=Corporate Finance Institute |publisher=CFI |access-date=}}</ref>
* 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.<ref name=PEISecBuy /><ref name=ForbSecBuy />

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 interest|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]] 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.<ref>{{cite web|last=MacKinlay|first=A. Craig|title=The Adjusted Present Value Approach to Valuing Leveraged Buyouts|url=http://finance.wharton.upenn.edu/~acmack/Chapter_17_app.pdf|website=Wharton|access-date=30 October 2016}}</ref><ref name=CFIModel />