The economical essence of LBO
Leveraged buyouts involve institutional investors and financial sponsors making large acquisitions without committing all the capital required for the acquisition.
To do this, a financial sponsor will raise acquisition debt (by issuing bonds or securing a loan) which is ultimately secured upon the acquisition target and also looks to the cash flows of the acquisition target to make interest and principal payments. Acquisition debt in an LBO is therefore usually non-recourse to the financial sponsor and to the equity fund that the financial sponsor manages
Typically the debt portion of a LBO ranges from 50%-85% of the purchase price
This kind of acquisition brings leverage benefits to an LBO's financial sponsor in two ways: (1) the investor itself only needs to provide a fraction of the capital for the acquisition, and (2) assuming the economic internal rate of return on the investment (taking into account expected exit proceeds) exceeds the weighted average interest rate on the acquisition debt, returns to the financial sponsor will be significantly enhanced
The most likely LBO targets are companies with low credit risk. In such a case, the positive factors for a leveraged buyout decision are stable cash flow, low financial leverage and predictable level of capital expenditure.
MBO (Management Buyout) is a variation of LBO, where a company's managers buy out their own company.
Typically, it is used when a company is economically depressed and its owners refuse to continue financing it.
In most cases, MBO is done with he help of third parties — banks or private equity funds, as managers usually do not have sufficient resources to acquire the company.