A leveraged buyout, commonly referred to as an LBO, might sound like a very complex term, but the reality is that you have seen it in practice more often than you think.
If you’re looking to buy an ongoing business, odds are that you probably don’t have enough cash on hand to purchase it. Even if you do, you might not want to do an all-cash purchase. This is where LBOs come into play. What you could do is pay a portion in cash, then use the assets of the business you are purchasing as collateral to borrow money to finalize the purchase. You would, in effect, be leveraging your new assets.
In practice, LBOs take many forms. The simplest one is probably a seller financing, where the person selling the business allows you to buy it and make payments for a number of years, while retaining a lien on certain assets of the company to ensure payment. The most complex LBOs are multi-billion-dollar transactions involving private equity firms and large banks.
As a buyer, an LBO is interesting because it allows you to acquire the desired business with a smaller cash expenditure. However, you need to be careful not to over-leverage the assets, since this may lead to a business that has too much debt to function on a day-to-day basis.
If you’re selling the business, the advantage of an LBO is that it allows you to effectively sell the business when you might have had trouble finding a buyer otherwise. If you’re providing seller financing, you do, however, retain some of the risk until you have been fully paid.