Investment Banking Tutorials
- Investment Banking Free Course
- Investment Banking Basics
- What is Investment Banking? (Overview of what do they actually do!)
- Investment Banking vs Commercial Banking
- Equity Research in an Investment Bank
- What is Asset Management Company AMC
- Sales and Trading in Investment Banking
- Private Placement, IPO and FPO in Investment Banking
- Investment Banking – Underwriters and Market Makers
- Investment Banking – Mergers and Acquisitions
- Investment Banking – Restructuring and Reorganisation
- Investment Banking Roles and Responsibilities
- Market Makers
- Propreitary Trading
- Deal Origination (Sourcing)
- Initial Public Offering (IPO)
- Top 4 Must Know Investment Banking Charts (Free Download Template included)
- Pitch Book | Guide to Investment Banking Pitch Book (Examples)
- What is LBO?
- Leverage buyout Lbo Analysis
- LBO Financing
- Trading Floor
- Market Order vs Limit Order
- Bid vs Ask
- Merchant Bank
- Best Investment Banking Books
- Nasdaq vs Dow Jones
- Nasdaq vs Nyse
- Differences Between NSE and BSE
- Investment Banking Careers
- Investment Banking Interview Questions (with Answers)
- How to get into Investment Banking?
- Investment Banking Job Description
- Investment Banking Division (IBD)
- Investment Banking Associate Salary
- Analyst vs Associate
- Investment Banking Job For Graduates (Engineers) | Top 8 Tips
- How to get an Investment Banking Internship?
- Top 10 Finance Certifications Programs
- Investment Banking Lifestyle
- Investment Banking Exit Opportunities
- Investment Banking Case Studies
- Top 10 Best Finance courses (with Online Certification)
- Investor Relation Job Description
- Financial Analyst Job Description
- Investment Banking vs Equity Research
- Investment Banking vs Asset Management
- Commercial Banking vs Merchant Banking
- Investment Banking vs Corporate Banking
- Portfolio Management vs Investment Banking
- Investment Banking vs Hedge Fund Manager
- Investment Banking vs Investment Management
- Investment Banking vs Private Equity
- Careers in Trading
- Investment Banking Firms
- Top Bulge Bracket Investment Banks
- Top Middle Market Investment Banks
- Top Boutique Investment Banks
- Investment Banking in Dubai
- Investment Banking In Nigeria
- Investment Banking in Abu Dhabi
- Investment Banking in Hong Kong
- Investment Banking in Russia
- Investment Banking in Brazil
- Investment Banking in China
- Investment Banking in Australia
- Investment Banking in Saudi Arabia
- Investment Banking in Singapore
- Investment Banking in London (UK)
- Investment Banking in India
- Investment Banking in Ireland
- Investment Banking in South Africa
- Investment Banking in Canada
- Investment Banking in Germany
- Investment Banking in France
- Investment Banking in Malaysia
- Investment Banking in Philippines
- Investment Banking in Boston
- Investment Banking in San Francisco
- Investment Banking in Chicago
- Investment Banking in Atlanta
- Investment Banking in Toronto
- Top Banks
- Top Banks in Australia
- Top Banks In Austria
- Top Banks In Bahrain
- Top Banks In Belgium
- Top Banks In Bermuda
- Top Banks In British Virgin Islands
- Top Banks In Brunei
- Top Banks In Canada
- Top Banks In Cayman Islands
- Top Banks In Denmark
- Top Banks In Finland
- Top Banks In France
- Top Banks In Germany
- Top Banks In Greenland
- Top Banks In Guernsey
- Top Banks In Ireland
- Top Banks In Isle of Man
- Top Banks In Japan
- Top Banks In Kuwait
- Top Banks In Liechtenstein
- Top Banks In Luxembourg
- Top Banks In Macau
- Top Banks In Norway
- Top Banks In Oman
- Top Banks in Pakistan
- Top Banks in Philippines
- Top Banks In Puerto Rico
- Top Banks In Qatar
- Top Banks In Saudi Arabia
- Banks in South Africa
- Top Banks In Singapore
- Top Banks In South Korea
- Top Banks In Sweden
- Top Banks In Switzerland
- Top Banks in UAE
- Top Banks in United Kingdom
- Top Banks in USA
- Banks in Nigeria
- Top 10 Banks in Netherlands
- Mergers and Acquisitions
- What is Mergers and Acquisitions?
- Mergers vs Acquisitions
- Synergy in M&A
- Successful Mergers and Acquisitions
- Financing Acquisitions
- Statutory Merger
- Joint Venture
- White Knight
- Hostile Takeover
- Golden Parachute
- Poison Pills
- What is Amalgamation?
- Spin off vs Split Off
- Forward Integration
- Backward Integration
- Horizontal vs Vertical Integration
- What is Divesting / Divestiture?
- Bootstrap Effect
- PAC MAN Defense
- Flip-In Poison Pill
- Flip-Over Poison Pill
- Tender Offer
- Friendly Takeover
- Amalgamation vs Merger
- Lobster Trap Defense
- Asset Purchase vs Stock Purchase
- Greenshoe Option
- Dawn Raid Takeovers
- Crown Jewels Defense
- Best Mergers and Acquisitions Books
- What is Asset Restructuring?
What is LBO?
LBO or leveraged buyout is basically acquiring a company with a small amount of equity (say 5-10% of the total cost) and using debt to fund the remaining (90-95%). This implies that the acquisition is done primarily using borrowed money and with this high leverage, the buyer (Private equity firms) hope to earn a higher return on its investments.
The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.
How does the LBO work?
In this section of what is LBO, we will try to understand how the LBO works using a simple example so that afterward the LBO financing becomes clear.
Let’s say that you have a business. It’s a great business and there’s no debt as of now and it generates a pre-tax income of $1.5 million a year. And your net income is $1 million assuming that you’re paying a third of what you earn to Government.
- Now Mr. B contacts you and praises your enterprise and desires to buy the company in $10 million. To you, it’s a great deal because you have been earning $1 million per year and $10 million looks pretty attractive to you. So you agree for the buy-out.
- Mr. B, on the other hand, checks his funds and finds out that he can only invest $1 million himself and the rest he has to arrange from somewhere else.
- So he asks a bank to lend him the rest of the amount. The bank disagrees to lend the money, thinking that it would be a risky business. Then Mr. B goes out and sees that your company has great assets. So he shows the assets of the company, uses the assets as collateral and convinces one of the banks to lend the money at 10% interest rate per annum.
- So Mr. B invests $1 million of his own funds and borrows $9 million from the bank and pays you off $10 million and buys the business. Now the business doesn’t consist of equity only. There are $1 million equity and $9 million in debt. So this would be called a leveraged buyout since debt is used heavily in this whole deal.
We will now check whether this deal is profitable for Mr. B or not. After buying the business, if we assume that the firm still generates $1.5 million in pre-tax income, here’s how the calculation will go.
- Even if the firm generates $1.5 million in pre-tax income, net income won’t be $1 million after paying $0.5 million taxes. Now, Mr. B needs to pay an interest on the borrowed funds. He has borrowed $9 million at the rate of 10% per annum.
- That means he needs to pay $900,000 as interest. That means, the company has the pre-tax income of ($1.5 million – $900,000) = $600,000. He will pay the same tax rate as the interest is tax-deductible.
- He will get a net income of $400,000 assuming that he would pay one-third part of the pre-tax income as taxes.
- Now this $400,000 is pretty good income if we compare what Mr. B has put in. He has put in $1 million of his own money. That means if the net income remains similar for the next 3 years, he would get back his invested money and more.
In this example, Mr. B has taken the help of the bank. In big deals, usually, the company targets a competitor company and takes help of private equity firm. Private equity firm then goes out and puts in some of its own money and takes a loan from other financial institutions.
Summary of LBO
This section of what is LBO summarizes most of the important features of LBO.
|Returns||Between 20%-30% generally|
|Exit Time Horizon||3-5 years|
|Capital Structure||A mixture of Debt (High) and Equity (low)|
|Debt Payment||Bank debt paid usually in 6-8 yrs. Higher yield debt paid in 10-12 yrs.|
|EXIT Multiples||EBITDA, PE, EV/EBITDA|
|Potential exits||Sale, IPO, Recapitalization|
This has been a guide to what is LBO? Here we explain LBO in a simple language along with examples. Here we also look at the features of Leveraged Buyouts in a table summary format. You may learn more about Investment Banking from the following articles –