A leveraged buyout (LBO) happens when one company acquires another using primarily borrowed money (e.g., loans and bonds), rather than its own cash or earnings.
In an LBO, the acquiring company puts up minimal equity while financing 70% to 90% of the purchase price through debt. Sometimes, the target company’s own assets serve as collateral for these loans, adding another layer of financial engineering to the deal.
Think of it like buying a rental property with a small down payment and a large mortgage, then using the rental income to pay off the loan. The strategy can multiply your returns—or amplify your losses.
In this guide, you’ll learn exactly how LBOs work, the different types of buyouts, and when this acquisition strategy makes sense for buyers and sellers alike.
How does a leveraged buyout work?
In an LBO, buyers purchase a company using mostly debt and minimal equity. The transaction typically combines the target company’s existing cash, new loans, and a small equity investment from the buyer. The existing owners sell their shares to the buyer, who takes on the acquisition financing, which usually includes a refinancing of the company’s debt.
The buyer then relies on the company’s assets and cash flow to service the debt while working to improve operations and eventually sell or refinance at a profit.
The LBO process: Step-by-step
The leveraged buyout process typically unfolds over several months and includes the following steps:
- Target identification:Private equity firms or strategic buyers search for companies with stable cash flows, undervalued assets, or operational improvement potential.
- Preliminary valuation: Buyers analyze the target’s financial statements, focusing on EBITDA (earnings before interest, depreciation, taxes, and amortization), cash flow generation, and asset values to determine a reasonable purchase price.
- Financing arrangement: The buyer structures the deal financing, typically combining bank loans, high-yield bonds, and mezzanine debt alongside their equity contribution.
- Due diligence: Extensive review of the target’s operations, finances, legal matters, and market position helps identify risks and opportunities.
- Negotiation and closing: Final purchase price and terms are negotiated, financing is secured, and ownership transfers to the buyer.
- Post-acquisition management: New owners implement operational improvements, cost reductions, or growth strategies to increase the company’s value.
- Exit execution: Typically after three to seven years, buyers sell the company through an IPO, strategic sale, or another buyout to realize returns.
LBO financing structure
The capital stack in a leveraged buyout combines multiple financing sources:
- Senior debt (50% to 60% of financing): Bank loans with first claim on assets, offering the lowest interest rates but strictest covenants.
- Subordinated debt (20% to 30%): High-yield bonds or mezzanine financing with higher interest rates and fewer restrictions than senior debt.
- Equity (10% to 30%): The buyer’s cash investment, which absorbs losses first but captures all upside after debt repayment.
This layered structure allows buyers to minimize their cash outlay while maximizing potential returns—if the acquired company performs well enough to service the debt.
Key players in an LBO deal
Several parties work together to complete a leveraged buyout:
- Financial sponsor: The private equity firm or investment group providing equity and orchestrating the deal.
- Management team: Existing or new executives who run the company post-acquisition, often receiving equity stakes.
- Investment banks: Advisers who help structure the deal, arrange financing, and negotiate terms.
- Lenders: Banks, credit funds, and bond investors providing the debt financing.
- Legal and accounting advisors: Specialists handling due diligence, documentation, and regulatory compliance.
Understanding the numbers behind LBOs
Typical debt-to-equity ratios
To qualify as an LBO, the debt-to-equity ratio on an acquisition typically ranges from 70:30 to as extreme as 90:10. This means if you’re buying a company for $100 million, you might invest just $10 million to $30 million of your own money and borrow the remaining $70 million to $90 million.
Here’s where it gets risky: Those monthly loan payments (called debt service) can be crushing. Miss a few payments, and the entire deal can unravel—taking your investment with it.
Leveraged buyout market statistics
After years of suppressed activity, the leveraged buyout market has experienced significant growth: Buyout investment value increased 37% year over year to $602 billion in 2024.
This resurgence came as the combined volume of leveraged loans and high-yield bonds across US and European markets more than doubled from 2023. The improved financing environment helped drive the number of deals, which increased 10% year over year to around 3,000 in the buyout market.
Unlike the 1980s when buyers started putting zero money down—financing 100% of acquisitions—today’s market maintains more conservative structures. Just like those “no money down” car deals that leave buyers with unmanageable monthly payments, the deals from that era set up companies for failure. This same pattern later infected the mortgage industry, triggering a wave of bankruptcies, foreclosures, and bank failures when borrowers couldn’t keep up with their massive monthly payments.
Types of leveraged buyouts
Not all LBOs follow the same playbook. The approach varies based on who’s buying and why.
Here are three common types of leveraged buyouts:
Management buyout (MBO)
The company’s existing management team uses borrowed funds to purchase the business from current owners, betting their insider knowledge will help them run it more profitably. In this type of LBO, management typically partners with private equity firms who provide financing and deal expertise in exchange for majority ownership.
MBOs often succeed because managers already understand the business’s operations, customers, and growth potential. They can move quickly post-acquisition without the learning curve that outside buyers face.
Secondary buyout
In this type of LBO, one private equity firm sells a portfolio company to another PE firm, using similar leveraged structures. The new buyer believes they can create additional value through different operational improvements, strategic acquisitions, or market timing.
These deals have become increasingly common as PE firms look to exit investments within their typical five- to seven-year holding periods, even when strategic buyers aren’t available.
Public-to-private buyout
Private investors or investment groups take a publicly traded company private, escaping the scrutiny and short-term pressures of public markets. Without quarterly earnings calls and activist shareholders, management can focus on long-term value creation with this type of LBO.
These transactions require premiums to convince public shareholders to sell, but buyers gain complete control to restructure operations without public oversight.
The advantages of leveraged buyouts
- Complete operational control: Taking a company private through an LBO removes the constraints of public ownership. New owners can restructure operations, cut costs aggressively, and make bold strategic moves without answering to public shareholders or quarterly earnings pressures.
- Massive return potential: Since LBOs require minimal upfront capital, your returns multiply if the acquired company generates enough cash to cover its debt payments and grow. Put up $10 million to acquire a $100 million company, and even modest improvements in value translate to outsized returns on your initial investment.
- Keeping businesses alive: When a company teeters on the edge of closure, an LBO can provide a lifeline. The acquisition brings fresh capital and management expertise, giving the business another chance to succeed rather than shutting down entirely.
The downsides of leveraged buyouts
The same leverage that amplifies returns also magnifies risks. Here’s what can go wrong:
- Workforce rebellion: In hostile takeovers especially, employees who never wanted new ownership may express their frustration through work slowdowns or outright stoppages. This resistance can cripple the very operational improvements the buyers need to make the deal work.
- Bankruptcy looms large: If the acquired company can’t generate enough cash to cover those hefty loan payments, bankruptcy becomes inevitable. Unlike other business challenges you might work through, excessive debt creates a ticking clock—miss too many payments, and creditors will force liquidation.
- Painful restructuring: While employees might hope new ownership brings fresh investment and growth, LBOs often require harsh medicine. Returning to profitability might mean mass layoffs, facility closures, and other decisions that devastate morale despite keeping the company afloat.
Today’s LBO landscape looks nothing like the ambitious 1980s leveraged buyouts. Stricter banking regulations enacted after that era’s excesses have made obtaining LBO financing significantly more challenging. Banks now demand higher equity contributions, stronger business fundamentals, and more realistic growth projections before they’ll fund these deals.
Leveraged buyout exit strategies
The endgame determines whether an LBO succeeds or fails. Buyers need clear paths to realize returns on their investment.
Here are three types of LBO exit strategies:
1. Initial public offering (IPO)
Taking the company public allows buyers to sell shares to public investors, often at substantial premiums to the original purchase price. IPOs work best when the company has strong growth momentum and favorable market conditions.
The IPO process typically takes six to 12 months and requires significant operational improvements to attract public investors. Buyers often retain partial ownership after the IPO to capture additional upsides.
2. Strategic sale
Selling to a strategic buyer—typically a larger company in the same industry—can generate premium valuations. Strategic buyers pay extra for synergies like cost savings, cross-selling opportunities, or market expansion.
These exits often happen faster than IPOs and provide complete liquidity for the PE firm. The acquired company becomes part of a larger organization, potentially accessing resources for continued growth.
3. Secondary buyout
Selling to another private equity firm has become an increasingly common exit route. The new PE buyer believes they can create additional value through different strategies or simply has a longer investment horizon.
While secondary buyouts may not achieve the highest valuations, they offer certainty of execution and allow the selling PE firm to fully exit their position within their fund’s lifecycle.
Leveraged buyout example
Consider this simplified LBO scenario to understand the mechanics and potential returns:
A private equity firm identifies a manufacturing company generating $10 million in annual EBITDA. They negotiate a purchase price of $50 million (five times EBITDA multiple).
The deal structure includes:
- $35 million in debt financing (70% of purchase price)
- $15 million in equity from the PE firm (30% of purchase price)
Over five years, the PE firm improves operations, increasing EBITDA to $15 million. They sell the company for $75 million (maintaining the five times multiple). After repaying the $35 million debt, the PE firm receives $40 million—a $25 million gain on their $15 million investment, or 167% return.
This simplified example shows how leverage amplifies returns. The company only grew 50% in value, but the equity investment generated 167% returns because debt financed most of the purchase.
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Leveraged buyout FAQ
What is a leveraged buyout in simple terms?
A leveraged buyout is when someone buys a company using mostly borrowed money instead of their own cash. The buyer typically puts down 10% to 30% in cash and borrows the remaining 70% to 90% to complete the purchase. The acquired company’s cash flow then pays back the loans over time.
What is a leveraged buyout example?
A real-life example of a LBO is Blackstone Group’s 2007 purchase of Hilton Hotels for $26 billion. The transaction was financed through $5.6 billion in equity and $20.5 billion in debt. After recovering from the effects of the financial crisis of 2009, Hilton was able to get a lower interest rate, refinance itself, and improve operations. This ultimately resulted in a 2013 sale that netted Blackstone a profit of $14 billion.
How does a leveraged buyout work?
In an LBO, buyers purchase a company using mostly debt and minimal equity. The transaction typically combines the target company’s existing cash, new loans, and a small equity investment from the buyer. The existing owners sell their shares to the buyer, who takes on the company’s debt plus the acquisition financing. The buyer then relies on the company’s assets and cash flow to service the debt while working to improve operations and eventually sell or refinance at a profit.
What factors make a good LBO candidate?
Strong LBO candidates have predictable cash flows, minimal capital expenditure requirements, and opportunities for operational improvement. Look for companies with strong market positions, experienced management teams, and assets that can serve as collateral. Industries with stable demand and limited technology disruption risk, like manufacturing and health care, typically work best for leveraged buyouts.
How long do LBO firms typically hold companies?
Private equity firms typically hold LBO investments for three to seven years, with five years being the average. This timeline allows enough time to implement operational improvements and debt financing restructuring while still providing returns within the PE fund’s 10-year life cycle. Market conditions and company performance ultimately determine the exact holding period.
What’s the difference between an LBO and a merger?
An LBO is a specific acquisition method using primarily borrowed money, while a merger combines two companies into one entity. In mergers, companies often use stock swaps or cash from their balance sheets. LBOs always involve high debt levels and typically result in the target company going private, while mergers can involve public or private companies in various combinations.
