Introduction to LBO Valuation

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A Leveraged Buyout is a type of M&A deal, in which the acquirer uses a high portion of debt to finance the transaction. In other words, this is an acquisition with high debt use. Typically, LBOs are carried out by financial buyers such as private equity or hedge funds. A bit less often, although it still happens, LBOs can be carried out by strategic bidders too.
In this video, you will learn:
- What is an LBO?
- Which are the mechanics of an LBO transaction
- When is this type of deal a feasible option
- Who are the lenders and what are the types of debt they provide
When screening for LBO targets the goal is to find a firm that produces stable operating cash flows and has relatively low debt financing prior to the transaction. The financial buyer comes in and uses a significant amount of leverage to fund the deal. So, once the acquisition is concluded the target becomes a highly levered entity. This allows financial buyers to invest a limited amount of equity.
Lenders are willing to finance the deal because the target has a solid underlying business, which is expected to generate a stable stream of cash flows. The target’s underlying business and assets are the only guarantees lenders have. Depending on the seniority of the particular loan facility, lenders will price potential risks in the interest rates they charge the target.
Besides financial buyers, the investors in LBO deals are also called financial sponsors. They provide the equity capital for the deal. The bet equity investors make is that in several years the target can repay a substantial portion of the leverage added to its balance sheet during the LBO. If everything goes well and the target does indeed manage to repay a good portion of its debt, equity sponsors can obtain a great IRR, provided that the capital they invested initially is a small fraction of the firm’s Enterprise Value.
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