How Does a Leveraged Buyout Model Work and Pros / Cons

 A leveraged buyout (LBO) is a type of financial transaction in which a company is acquired using a significant amount of borrowed money, with the acquired company's assets serving as collateral for the loans. The purpose of an LBO is typically to acquire a controlling interest in a company, and the buyer is usually an investment firm, private equity firm, or a group of investors. The goal is to achieve a high return on investment through the acquisition and subsequent management of the company, and to eventually resell the company at a profit.

At a high level, nearly every single one of my startup financial models I've built on this site has the ability to account for a leveraged buyout. That is because I have always built in an option for some of the startup costs / initial investment / burn to be funded with a loan. So, when you go to fill in the assumptions, on the 'startup costs' tab you would just make one of the inputs the 'cost to acquire'. This flows through to the total equity requirement and you can choose to finance a large portion of that if you were doing an LBO. 

The rest of the model can then be configured for the assumptions / revenues / expenses / cash flow and potential exit at some point in the future. The entire simulation will show the ROI, IRR, and equity multiple of the transaction. There will also be an option for investors to come in with some of the investment required and their relevant shares are determined.

I have built nearly all the templates for starting a business with this in mind so they can all be considered capable of performing an LBO modeling analysis.

Nearly all of these financial models have LBO functionality: 

There is risk involved in doing this type of deal.

Pros and Cons of an LBO Transaction

Pros of a leveraged buyout (LBO) include:
  • High returns: LBOs can generate high returns for investors, as the use of leverage can amplify the returns on their equity investment.
  • Restructuring opportunities: LBOs can provide an opportunity to restructure a company, improve operations and cost efficiencies, and return the company to profitability.
  • Increased control: LBOs can provide buyers with increased control over the acquired company, allowing them to make strategic decisions that can lead to improved performance.
Cons of an LBO include:
  • High risk: LBOs are highly leveraged transactions, which means that they involve a significant amount of debt and can be risky for investors.
  • Difficulty in servicing debt: The high levels of debt involved in an LBO can make it difficult for the acquired company to meet its debt obligations, which can lead to financial distress.
  • Negative impact on credit rating: LBOs can negatively impact the credit rating of the acquired company, making it more difficult and expensive to borrow money in the future.
  • Job loss: LBOs often lead to layoffs and other cost-cutting measures in order to improve the company's financial performance, which can negatively impact employees.
  • Short-term focus: LBOs are often focused on short-term financial gains, at the expense of long-term growth and stability.
Types of Companies that an LBO Makes the Most Sense For
  • Mature companies: These are companies that have been in operation for a long time and have a stable cash flow, but may be facing growth or profitability challenges. LBOs can provide these companies with the capital they need to restructure and improve their operations.
  • Underperforming companies: These are companies that are not performing as well as they could be, due to a variety of factors such as poor management or a challenging market environment. LBOs can provide these companies with the resources and expertise they need to turn things around.
  • Cyclical companies: These are companies that operate in industries that are prone to fluctuations in demand and prices, such as the energy or real estate sectors. LBOs can provide these companies with the capital they need to weather downturns in their industries.
  • Private companies: Private companies, particularly family-owned businesses, may find LBOs an attractive option for transferring ownership and management to professional investors.
  • Businesses with a niche market: Businesses that have a unique product or service and are market leaders in that niche may find LBOs as an attractive option as the acquirer can leverage the company's established market position to generate strong returns.
It is important to note that LBOs can be done on companies of different size and in different industries, not just the above mentioned.