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The History of the Leveraged Buy-Out

A LBO is an acquisition of a public or private company where the takeover is financed predominantly by debt with a minimum equity investment.

The leveraged buyout boom of the late 1980's gave way to the buyout bust of the early 1990's.
Assets of the acquired company act as collateral for the debt and interest and principal obligations are met through cash flows of the refinanced private company.

The volume of LBO’s peaked in the late 1980’s, and although the larger transactions received the most attention, the vast majority of buyouts have been of small to midsized companies with deal values less than US$250 million. In addition, LBO’s represent a small fraction, well below 10%, of total M&A transactions.

The LBO as a takeover mechanism had been common for decades, but its sudden rise in the 1980’s was due to a number of converging regulatory and economic factors in the US. The government effectively relaxed policies on antitrust and securities laws that led to the approval of mergers that would previously have been challenged. The deregulation of many industries also provided opportunities for mergers and restructuring. Finally, the decade saw the development of high-yield debt or “junk bonds”, which provided LBO firms with the huge amounts of required capital.

In examining the empirical evidence, some of the biggest beneficiaries of the LBO boom were the shareholders of the targeted companies, who routinely saw their stock holdings gain around 30-50% over pre-offer prices. The LBO firms themselves fared significantly worse in terms of return and some studies show that bidders in the 1980’s suffered losses, on average, largely as a result of increased competition for targets.

Private equity can take many forms, including leveraged buyout, venture capital, recapitalization, growth capital, and mezzanine capital

Some argue that the LBO phenomena was detrimental for many existing corporate stakeholders including employees, bondholders, customers, and suppliers, but there is a lack of consistent evidence to support this. Others claimed that the constant threat of a hostile takeover forced managements to focus on short-term defensive policies at the expense of long-term planning, but again, there is a lack of empirical support.

Every leveraged buyout is a bet on the economy

In many cases, the discipline imposed on a company by the high debt burden of an LBO transaction can have a value-enhancing effect. It forces management to improve efficiency, eliminate wasteful corporate expenditure, avoid value-diluting acquisitions and encourages the sale of low-performing divisions. In effect, it aligns management and shareholder interests.

Today the market is witnessing a resurgence of the LBO and the completion of large deals. The rise is currently being driven by pools of institutional money seeking returns, a growing number of LBO funds with impressive track records and the continued availability of cheap debt. Maybe it is only a matter of time before the infamous RJR Nabisco transaction loses its top spot.

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