Companies selling into an established, well-defined market (automotive pumps and valves, soft drinks) are more conducive to an LBO transaction than those companies selling into a fledgling market (cloud computing, social networks, nanotech); while growth prospects for the company are important, they are secondary to …

A leveraged buyout is when one company acquires another using a significant amount of financing, meaning the buyout is funded with debt. The company doing the acquiring in a leveraged buyout, typically a private equity firm, will use its assets as leverage.

Jerome Kohlberg, Jr.

The purchaser secures that debt with the assets of the company they’re acquiring and it (the company being acquired) assumes that debt. The purchaser puts up a very small amount of equity as part of their purchase. Typically, the ratio of an LBO purchase is 90% debt to 10% equity.

A leveraged buyout is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. In a leveraged buyout (LBO), there is usually a ratio of 90% debt to 10% equity.

For the most part, a company’s existing capital structure does NOT matter in leveraged buyout scenarios. That’s because in an LBO, the PE firm completely replaces the company’s existing Debt and Equity with new Debt and Equity.

The largest leveraged buyout in history was valued at $32.1 billion, when TXU Energy turned private in 2007.

LBO is leveraged buyout which happens when an outsider arranges debts to gain control of a company. MBO is management buyout when the managers of a company themselves buy the stakes in a company thereby owning the company. In MBO, management puts up its own money to gain control as shareholders want it that way.

An LBO analysis can also provide a “floor” valuation of a company, useful in determining what a financial sponsor can afford to pay for the target company while still realizing a return on investment above the financial sponsor’s internal hurdle rate.

A leveraged buyout (LBO) valuation method is a type of analysis used for valuation purposes. This analysis is carried out in order to project the enterprise value of a company by the financial buyer that acquires it.

An LBO candidate is considered to be attractive when the business characteristics show sustainable and healthy cash flow. Indicators such as business in mature markets, constant customer demand, long term sales contracts, and strong brand presence all signify steady cash flow generation.

Valuation Key Steps In order to perform an LBO valuation, the following is required (as a minimum): An operating model, forecasting EBIT and EBITDA. A debt repayment model forecasting how debt will develop from acquisition to exit. An assumption of when and at what multiple the LBO investor can exit.

4. Calculate cumulative levered free cash flow (FCF).

1. Start with EBT (Tax-effected) and then add back non-cash expenses (D&A).
2. Subtract capital expenditures (Capex).
3. Subtract the annual increase in operating working capital to get to Free Cash Flow (FCF).
4. Calculate Cumulative Free Cash Flow during the life of the LBO.

A dividend recapitalization is often undertaken as a way to free up money for the PE firm to give back to its investors, without necessitating an IPO, which might be risky. A dividend recapitalization is an infrequent occurrence, and different from a company declaring regular dividends, derived from earnings.

For one, they usually only benefit a select group of investors or shareholders. And they typically damage a company’s credit rating, which can irk creditors and common retail investors. Plus, once dividend recaps are complete, the company itself has to pay back the debt or it will eventually file for bankruptcy.

A corporation may borrow money to pay a cash dividend when the company’s retained earnings in a given year do not support the dividend payment. Paying the dividend with borrowed funds, they may believe, signals their confidence that future cash flows will pay off the loan and support a continuing dividend stream.

Companies can pay dividends from either current profits or retained earnings. If their cash flows are negative, companies typically either tap into their reserves or take on additional debt to fund the payouts.

Dividend recapitalization is a transaction in which a company borrows in order to pay a large (or “special”) dividend. In doing so, the company significantly changes its capital structure, as net debt increases while equity is dramatically reduced.

During a recession, dividend cuts or eliminations are an investor’s enemy and represent a reduction in income and loss of capital as the stock price declines, says Benjamin C. Halliburton, chief investment officer at Tradition Asset Management.