Leveraged buyout in the words of Brigham and Daves (2007) can be seen as a situation whereby "a small group of investors, usually including current management, acquires a firm in a transaction financed largely by debt." As the authors further point out, the debt in this case could be settled through the sale of the acquired company's assets or through the utilization of the funds the acquired company generates from its operations. In that regard, most leveraged buyouts utilize the assets of the target entity as collateral for the borrowed funds. It should however be noted that in some instances, the acquiring company's assets could also be used as collateral (in addition to those of the acquired company).
According to Anson (2008), LBO deals typically have three distinct financing tranches. These tranches according to the author are "senior debt, mezzanine debt, and equity" (Anson, 2008). In basic terms, senior financing comprises of bank financing as well as insurance and credit company...
On the other hand, mezzanine debt as the author points out is purchased by a form of private equity referred to as mezzanine debt funds. Lastly, we have equity which will in the words of the author "be held by the LBO firm that has taken the company private, the management of the company, and some 'equity kickers' from the mezzanine debt tranche" (Anson, 2008).
While there are those who view leveraged buyouts as some form of aggressive business practice, such deals do have some distinct advantages. For instance, leveraged buyouts allow or permit companies to make investments, i.e. The acquisition of other business entities, using very little capital. In this case, the acquiring company could benefit significantly should the returns of the acquired company exceed the cost of debt financing. Further as Anson (2008) points out, shareholders may respond positively to LBOs largely because such deals offer a higher price for their shares relative to the market price. It…
