Leveraged Buyout in the Words of Brigham

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 financing. 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 is however important to note that not every leveraged buyout turns out to be successful. For instance, a leveraged buyout could backfire should the returns of the acquired company fail to exceed the cost of debt financing. This could effectively bankrupt the acquired company.

In recent times, several leveraged buyouts have been publicized in the media. Although a number of these buyouts were largely successful, some did not achieve their stated or desired objectives. One particular LBO which according to Brigham and Daves (2007) could be regarded spectacularly successful is the Gibson Greeting Cards deal. According to the authors, this particular purchase was financed using a total debt of $79 million and a total equity of $1 million. The buyout was hence clearly highly leveraged. The key principals in this deal were Raymond Chambers and William Simon. In the words of the authors, "less than 18 months later, Simon's personal investment of $330,000 was worth $66 million in cash and stock" (Brigham and Daves, 2007). The 2006 acquisition of HCA Inc. By a group of three companies can be regarded a more recent example of a successful LBO. However, not all LBOs have been so successful. Federated Department Stores' LBO can be regarded a failure. In this particular case, the acquired company filed for bankruptcy only one year after being acquired. As I have already pointed out elsewhere in this text, one of the main disadvantages of leveraged buyouts is the risk associated with failure to keep up with high interest payments. Indeed, this remains one of the key factors that have over time triggered the failure of many LBOs. In that regard, in an attempt to enhance an LBO's chances of success, a buyer must first evaluate the financial viability of the said buyout.