Leveraged Buyout

A leveraged buyout is a method of buying a company without paying the full purchase price out of one’s own pocket. The buyer — usually an investment firm — puts up only a small portion of the money itself and borrows the rest from banks. What matters most is who ultimately bears the debt: not the buyer, but the acquired company itself. It must repay the loans taken out from its own revenues. The term combines “leverage” (the use of borrowed capital to amplify effect) and “buyout” (the purchase of all shares in a company). The leverage describes how a large effect is achieved with little of one’s own money.

Leverage as a Promise of Returns

Why would anyone take this detour through loans? Because it greatly increases the return. A simple calculation example: An investor buys a company for 100 million euros. If he puts up the entire amount himself and later sells it for 150 million, he has made a 50 percent profit. But if he puts up only 20 million himself and borrows 80 million, he makes the same profit from the sale — but relative to his own stake, that is many times more.

This is exactly why the procedure is so attractive to investment firms, the so-called private equity companies. They manage their investors' money and want to achieve the highest possible profits. The debt leverage is a central tool in this. However, it works in both directions: if business performs worse than expected, the company cannot service the loans — and runs into serious trouble.

The Course of a Typical LBO Transaction

First, the investment firm sets up a new, empty company — a so-called holding company. This shell takes out the loans and uses them to buy the target company. After the purchase, the two are merged, so that the target company now directly carries the debt. This sounds technical, but it has a clear consequence: the company’s profits do not flow into new investments but first go toward debt repayment.

The investment firm typically holds the company for three to seven years. During this time, it tries to make it more efficient: cutting costs, selling off business divisions, opening up new markets. In the end, the company is sold again — either to another corporation or taken public. The proceeds from the sale are first used to settle the remaining debt, with the rest being the investors' profit.

How high the share of debt financing may be depends on the company. Banks prefer to lend money to firms with stable, predictable revenues — such as an energy utility or a supermarket chain. Companies with strongly fluctuating profits are considered riskier and receive correspondingly less credit.

LBOs in the News and Well-Known Cases

One of the most famous LBOs in history was the acquisition of RJR Nabisco in 1988 for around 25 billion US dollars at the time — a deal that was later immortalized in a book. More recently, Elon Musk’s purchase of Twitter in 2022 for 44 billion dollars made headlines: he too financed part of it through bank loans that were directly saddled onto the company. The company has been struggling with substantial interest payments ever since.

The term appears in business news whenever well-known brands are suddenly sold, broken up, or restructured. Often a private equity firm is behind it, having acquired the company through an LBO. Critics accuse this model of burdening companies unnecessarily and endangering jobs, since profits are not reinvested but used to repay debt. Supporters counter that the pressure to become efficient is what makes many companies competitive again.

A common misconception: many people confuse an LBO with a hostile takeover. Both are company acquisitions, but an LBO says nothing about whether management agrees or not. An LBO describes exclusively the financing structure — that is, the high proportion of debt. The takeover itself can take place with mutual consent or against the will of the company.