What is a leveraged buyout (LBO)?

A leveraged buyout (LBO) refers to an acquisition of a company that is primarily financed through borrowed funds, such as loans or bonds, to cover a significant portion of the purchase price. This method allows the acquiring entity, often a private equity firm, to use a relatively small amount of its own capital while leveraging debt to amplify the potential return on investment.

The key characteristic of an LBO is the use of leverage, which enhances the financial capability to purchase the target company while spreading the risk across the debt incurred. After the acquisition, the cash flows generated by the acquired company are typically used to service the debt, and any operational improvements or restructuring are aimed at increasing profitability, thereby benefiting the equity holders once the debt is repaid.

This contrasts sharply with other forms of acquisitions, such as those funded primarily by equity or purchases made without any debt obligations. An LBO specifically highlights the balance between risk and reward through the strategic use of debt financing.