A leveraged buyout is a buyout that utilizes borrowed money to cover the costs of the acquisition, rather than spending money out of the purchasing company’s pocket to complete it. A leveraged buyout is a strategic move that companies can use to acquire other companies without having to commit large amounts of their own capital, which can potentially hinder their operations during and after the buyout.
If you have been approached for a buyout, understanding how leveraged buyouts work can help you negotiate the deal more effectively. Buyouts, mergers, and acquisitions are all governed by federal and state business law.
Reasons for Leveraged Buyouts
Often, leveraged buyouts are conducted by private investment firms. There are a few reasons why an investment firm would conduct a leveraged buyout, and these include:
- Reducing the purchaser’s tax bill. Firms pay taxes on the equity they directly transfer, not the interest payments they make. Having interest payments to make on borrowed money can actually reduce the firm’s taxes;
- There is a potential for a greater return rate on the investment by borrowing money to purchase the other company;
- Operating the acquired company more efficiently. The firm might feel they can do a better job of running the business than its current owners and opt to buy them out; andTo make a public company private.
Completing a Leveraged Buyout
In a leveraged buyout, the buyer uses the assets of the company being purchased as collateral for the loans to cover the buyout cost. In many cases, the acquiring company’s assets are also used as collateral.
At the most basic level, a leveraged buyout looks like this:
- A larger company or investment firm sees a profitable, growing company and determines it has an interest in operating that company;
- The smaller company can be purchased for $15 billion. Rather than spending $15 billion on the purchase to own the smaller company outright, the buyer commits $5 billion of its own money and borrows the remaining $10 billion, using both companies’ assets as collateral for this loan;
- Upon taking control of the smaller company, the buyer reorganizes it to make it run more efficiently. With the acquired company’s profits, the buyer repays their debt from the purchase loan.
There are some drawbacks to a leveraged buyout, such as a negative impact on the buyer’s credit rating because of the high debt payment and the potential that after reorganization, the acquired company will not continue to be profitable, putting the buyer at a loss.
Work with an Experienced Business Lawyer
Leveraged buyouts can be complicated. When you are on either side of this type of transaction, it is important that you always know your rights and all of the options for your business. To learn more about buyouts and other types of acquisitions, contact our team of experienced business lawyers at Moen Sheehan Meyer, Ltd. today to set up your initial consultation with us.