What is a leveraged buyout?
Model answer
A financial sponsor (PE firm) acquires a company using a large portion of borrowed money, with the target's own assets and cash flows supporting the debt. The goal is to generate equity returns through debt paydown, operational improvement (EBITDA growth) and multiple expansion, then exit in ~3-7 years.
⚠ Common wrong answer: "The PE firm borrows the money and pays it back out of its own fund." Why it fails: The debt sits on the TARGET's balance sheet and is serviced by the target's own cash flows — the sponsor's downside is capped at its equity check. That non-recourse structure is what makes high leverage viable at all.
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More from LBO & Paper LBO
- What makes a company a good LBO candidate?
- What drives returns in an LBO?
- Why does using more leverage increase equity returns (when it works)?
- At a high level, how do you calculate the IRR or money multiple on an LBO?
- Name the three primary value-creation (returns) drivers in an LBO.
- Of the three returns drivers, which is considered the highest quality and which is the lowest quality, and why?
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1 / 3What makes an acquisition accretive or dilutive to EPS?
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