Leveraged buyout and Management Buyout

What is a “Leveraged buyout (LBO)”?

• LBO = Acquisition of a company (or a part of a company or it can also be single asset like a real estate) using a substantial amount of borrowed money (bonds or loans /  debt) to meet the cost of acquisition.
• The financial buyer (e.g. private equity fund) puts a small amount of equity (relative to the total purchase price) and utilizes leverage (debt or other non-equity sources of financing) to fund the rest of the amount that is paid to the seller.
• LBOs can have many different forms such as Management Buy-out (MBO), Management Buy-in (MBI), secondary buyout, tertiary buyout, etc.

Can LBO be employed in public companies also?

• YES. Though, mostly LBOs occur in private companies, but it can also be employed with public companies.

The +ves of Leveraged buyout::

• In LBO transactions, financial buyers seek to generate high returns on the equity investments and use financial leverage (debt) to increase these potential returns.
• Financial backers of Dell are of the view that it will be easier to engineer a turnaround without having to pander to the stock market’s fixation on whether the company’s earnings are growing from one quarter to the next.
• Taking the company private will leave it without publicly traded shares to attract and reward talented workers or to help buy other companies.

The -ves of Leveraged buyout:

• LBOs need companies to reserve some of their incoming cash to reduce the debt taken on as part of the process of going private.
• The obligations mean Dell will have less money to invest in innovation and expansion of its business.

Equity holders – Risk arises due to significant financial leverage. Interest amount that has to be paid for the debt taken by the company are are "fixed costs" and thus they can in future force the company into default if they not paid.
Debt holders – The debt holders assume the risk of default compared with higher leverage as well, but as they have claims on the assets of the company, they are likely to realize a partial, if not full, return on their investments, even in bankruptcy.

What is “Management Buyout (MBO)”?
MBO is quite similar to a LBO, but the difference is that in an MBO the Management Team of the target company acquires the company instead of a financial sponsor as in case of a LBO.