LBO - An overview

Leveraged buyout (LBO) is the acquisition of a company (buyout) by a fund (the sponsor), in which a significant portion is financed through borrowing (leverage). In most banks (the lenders), this refers to the leverage finance or LevFin team. The key distinction in using more debt to buyout a significant portion of the company is that it allows for (1) lower upfront capital and (2) amplification of returns on equity. Other benefits include tax shield from debt. 

In summary, sponsors use significant debt to maximise equity and amplify returns to acquire companies which they think have the potential to grow and generate value for stakeholders. The success of an LBO depends on:

1. Target management's ability to implement a sound and long-term strategy
2. Evolution of the industry
3. The target's intrinsic value - qualities, products, services, brand etc.
4. Value creation especially with the sponsors' expertise and ability to support the target management team. E.g. providing access to its network, sharing best practices and expertise.

LBO is a 3-step process: acquire, monitor and exit. The monitoring phase typically lasts 4-5 years and is key as it is where value is created via:

1. EBITDA growth: increasing organic sales and margin improvement
2. Cash generation / deleveraging: reduces cost of capital, optimise capex
3. Strategic value / valuation multiple: growth profile, financial markets conditions at exit

There are several ways a fund can exit its LBO investments:

1. Trade sale: full disposal at price premium
2. IPO
3. New LBO (secondary, tertiary): for newcomer to join as minority or non-controlling shareholder
4. Continuation fund: another fund set-up by the sponsor to continue supporting the investment over the long-term

How banks come in: Levfin teams in banks support the sponsor via the provision of debt at the holdco level. The debt is then repaid via cashflows from the target company (opco). Banks could also provide advisory services for sponsors and target companies on the LBO transaction, including valuation, deal structuring, negotiation and syndication.