Leveraged Buyout (LBO) Model (2022)

What is a Leveraged Buyout (LBO)?

A leveraged buyout model, or an LBO, is a term used for the acquisition of a company. It is a type of acquisition where total acquisition proceeds are financed with a substantial portion of borrowed funds. There are two parties involved in a leveraged buyout – the buyer company & the target company. In LBO, the acquiring firm finance the acquisition with a mix of equity & debt.

LBO is very much like buying a house on a mortgage. When we buy a house on a mortgage, we put down some money in cash (down payment) & the remaining payment is made by loan (i.e., debt). The house itself works as a security for the debt. Most of the time, loans form a major part of the entire payment. Similarly, in LBO, the target company’s assets work as security for the debt, and the majority of finance is debt. The buyer company is usually a private equity firm that invests a small amount of equity and majorly uses leverage or debt to fund the remaining transaction.

Table of Contents

  1. What is a Leveraged Buyout (LBO)?
  2. Example of Leveraged Buyout (LBO) Model
    1. Why LBO Model?
    2. Caution
  3. Steps Involved in Building a Leveraged Buyout Model
    1. Step-1 – Purchase Price and the Amount of Debt and Equity
    2. Step-3 – Build Projections
    3. Step-5 – Analyse Repayment Structure
    4. Step-6 – Exit
    5. Step-7 – Calculating IRR on Initial investment
  4. Leveraged Buyout (LBO) Analysis
  5. Leveraged Buyout Vs. Recapitalization

The leveraged buyout has had its share of negative publicity. Many people consider it a ruthless, predatory strategy because the assets of the target company are often the collateral for the debt to finance the leveraged buyout. The target company does not usually sanction this. But there are certain advantages to LBO for the target company as well. The acquiring company usually targets companies in trouble, maybe financially or in any other way. After the buyout, the acquiring firms channelize the target company’s decision-making process through their own expertise. Normally, such private equity firms exit it at a suitable time when they are able to realize higher value for the stake in the company.

Example of Leveraged Buyout (LBO) Model

Let us understand the concept of a leveraged buyout with a simple example –

Suppose XYZ Corp. wants to buy ABC Corp without investing a lot of capital. The value of ABC Corp. is USD 2000.00. XYZ Corp. invests USD 200.00 of its own equity & the remaining USD 1800.00 it borrows at an interest rate of 5% per year.

(Video) LBO Model: Leveraged Buyout Model Tutorial

Why LBO Model?

In the first year of operations, XYZ Corp earns USD 200.00 (10%) from the cash flow of ABC Corp. Now the total value of ABC Corp. is USD 2200.00. XYZ Corp. repays its interest on debt, i.e., USD 90.00 (5% of USD 1800.00). As you can see, the company is paying interest of USD 90 to the financial institutions for its investment of USD 1800. Thus XYZ is left with USD 110.00 (USD 200.00 – 90.00) available for equity shareholders. XYZ Corp earns USD 110 on its original investment of USD 200.00. Thus, XYZ earned a 55% return on equity on this transaction.

Now let’s consider how much return XYZ Corp. would have earned had it financed the entire transaction by equity. To acquire ABC Corp, XYZ Corp. has to invest USD 2000.00. In the next year, XYZ Corp. earned USD 200.00 from the cash flow of ABC Corp. Thus its total return = (200/2000) * 100 = 10%.


Thus we can clearly see that the returns on leveraged buyout are much higher than a regular transaction.

This example shows a very good return on equity because there is a positive effect of leverage here. This depends on the return on investment, i.e., 10% here.

If this return reduces to 4%, the return on equity will be negative. How? Amount left for equity shareholders is $80 (4% on 2000) less $90 (Interest) i.e. – $10 ~ -5%.

If this return reduces to 5%, the return on equity will be minimal. How? Amount left for equity shareholders is $100 (5% on 2000) less $90 (Interest) i.e. $10 ~ 5%.

If this return reduces to 6%, the return on equity will be average. How? Amount left for equity shareholders is $120 (6% on 2000) less $90 (Interest) i.e. $30 ~ 15%.

(Video) Basic leveraged buyout (LBO) | Stocks and bonds | Finance & Capital Markets | Khan Academy

Leveraged Buyout (LBO) Model (1)

Steps Involved in Building a Leveraged Buyout Model

Step-1 – Purchase Price and the Amount of Debt and Equity

The first step in a leveraged buyout is determining a purchase price for the target company. This is a valuation of the company based on various factors within and outside the target company. Once the purchase price is fixed, the buyer must decide what percentage of equity & what percentage of the debt he will use to carry out the acquisition.

Step-2 – Listing Sources of Finance & Types of Debts Available

We already know the two types of finances that fund a leveraged buyout are equity & debt. We also know the source of equity, but various types of debt are available to the buyer. These sources include bank debt, bonds, commercial papers, etc. The acquiring company must decide on what type of debt it wants to exercise depending on interest rates, repayment terms, etc.

Step-3 – Build Projections

The acquiring company must build a future balance sheet & income statement projections for the target company. This will help to determine the rate of return from the investment. The buyer must have an approximation for revenue growth, income & expense percentage, net income margin, etc. The buyer can go one step further & compare their own projection calculations with that of equity researchers to account for any discrepancy.

Step-4 – Calculating Cash Flow & Cash Available for Cash Repayment

Further, after building projections, it is necessary to calculate cash flows. There are various different cash flows such as free cash flow to equity, free cash flow to the firm, unlevered free cash flow, etc. Our motive to calculate cash flow is to calculate cash available for repayment. We will get that by the following formula –

Cash Available for Debt Repayment = Beginning Cash + FCF – Minimum Cash Balance


FCF (Free Cash Flow) = Cash Flow from Operations – Capital Expenditure & Minimum Balance

(Video) Leveraged Buy Outs Explained Simply

Minimum Balance = least amount of cash that a company needs to continue operating, paying employees, and paying for standard expenses

Step-5 – Analyse Repayment Structure

Every type of debt comes with a repayment structure, which says how much debt is payable and at what time. Some of this repayment is mandatory, while some are optional. The acquiring company should be sure that it can adhere to at least all the mandatory repayments in a timely manner. The projections and estimates are very useful in analyzing this debt repayment structure.

Step-6 – Exit

As we already know that most of the time, leverage buyout is a method of earning a good return on investment for a private equity firm. Thus it is necessary that the acquiring firm has an exit strategy in place. At least the acquiring firm has some assumptions about how & when it will exit. A standard assumption would be that the target company will be sold after 5 years at the same implied EBITDA multiple at which the company was purchased. The basic understanding is that upon exit, the acquiring firm will repay all the debt obligations of the target company as a part of the owner’s obligation. But it also gets all the company’s remaining cash at the end of the period as an owner.

Step-7 – Calculating IRR on Initial investment

The purpose of building a leveraged buyout model (LBO) is to calculate returns and determine if the LBO deal is attractive or not. The acquiring company looks at IRR to determine the attractiveness of an LBO. Thus, the buyer derives an IRR from all the estimates of future projections and related research in the final step.

IRR= (Cash Flows)/ (1+r)i


Cash flows= cash flows in the time period

(Video) Financial modeling tutorial: Leveraged buyout (LBO) modeling.

r= Discount rate

i= Time period

Leveraged Buyout (LBO) Analysis

Leveraged Buyout Analysis is similar to Discounted Cash Flow Analysis, in which the future cash flows are discounted to reach a particular present value. However, in Leveraged Buyout, most analysts calculate an internal rate of return (IRR) to analyze the benefit of acquiring a target company. The internal rate of return is nothing but the rate at which the present value of future cash flows becomes zero. The higher the IRR, the more fruitful the Leveraged Buyout.

Leveraged Buyout Vs. Recapitalization

Many people confuse Leveraged Buyout with Leveraged Recapitalization. Even though the base concept is the same in both strategies, there is one striking difference. In leveraged buyouts, significant debt is taken to finance the acquisition transaction, whereas, in a leveraged recapitalization, the debt is taken to restructure the company’s capital structure.



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  • Wealth Maximization
(Video) Financial Modeling Quick Lesson: Simple LBO Model (1 of 3)


What is a leveraged buyout LBO model and what is it used for? ›

A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the assets of the acquiring company.

What is an example of a leveraged buyout? ›

Private equity companies often use LBOs to buy and later sell a company at a profit. The most successful examples of LBOs are Gibson Greeting Cards, Hilton Hotels and Safeway.

What are the 3 types of LBOs? ›


These are 1) taking a public company private, 2) financing spin-offs, and 3) carrying out private property transfers frequently related to ownership changes in small business.

What is leveraged buyout strategy? ›

Leveraged buyout (LBO)

Share. A leveraged buyout (LBO) occurs when the buyer of a company takes on a significant amount of debt as part of the purchase. The buyer will use assets from the purchased company as collateral and plan to pay off the debt using future cash flow.

What type of debt is used in an LBO? ›

In a leveraged buyout (LBO), the company uses leverage, or debt, in order to acquire another company or one of its parts. In an LBO, private equity funds can use multiple types of debt or capital as leverage. The most common types of capital or debt used are a Revolver, Bank Debt, and High Yield Debt.

What is the difference between LBO and DCF? ›

An LBO type analysis models cash flows to and from various parties and from that you can calculate a rate of return to each party; a DCF models cash flows and a required rate of return, based on risk, in order to value a company or particular security.

Who pays the debt in an LBO? ›

High Yield Debt/Subordinated Debt

In the event of a liquidation, high yield debt is paid before equity holders, but after the bank debt. The debt can be raised in the public debt market or private institutional market. Its payback period is typically 8 to 10 years, with a bullet repayment and early repayment options.

Who bears the debt in an LBO? ›

A leveraged buyout (LBO) is when one company buys another company using mostly borrowed money. The buyer puts up the company being bought as collateral for the loan, and the purchased company assumes the debt on the loan.

What is the difference between LBO and MBO? ›

A leveraged buyout (LBO) is when a company is purchased using a combination of debt and equity, wherein the cash flow of the business is the collateral used to secure and repay the loan. A management buyout (MBO) is a form of LBO, when the existing management of a business purchase it from its current owners.

What makes a good LBO target? ›

What Makes a Good LBO Candidate? LBO Candidates are characterized by strong, predictable free cash flow (FCF) generation, recurring revenue, and high profit margins from favorable unit economics.

How do you use an LBO model to value a company? ›

Valuing an LBO

The expected exit net debt is deducted from the EV to get to the expected exit equity valuation. The expected equity value at exit is then discounted back to the deal date using the buyers minimum IRR requirement. This, in turn, gives the maximum equity investment by the buyer (entry equity valuation).

What happens to existing debt in LBO? ›

For the most part, a company's existing capital structure does NOT matter in leveraged buyout scenarios. That's because in an LBO, the PE firm completely replaces the company's existing Debt and Equity with new Debt and Equity.

Can anyone do a leveraged buyout? ›

In principle, a buyer can acquire a business with 'no money down' if the seller's asking price is lower than the value of the company's assets. For this strategy to work, the seller has to sell the company for 90% of the assets value (or less).

How do I calculate my LBO debt? ›

To figure out the amount of debt used in an LBO, you need to figure out the purchase multiple and how much you're paying for the company first. And then the amount of debt will come from that. So you estimate the purchase price and then debt to EBITDA by looking at comparable leveraged buyout deals.

Who invented leveraged buyout? ›

In fact, it is Posner who is often credited with coining the term "leveraged buyout" or "LBO." The leveraged buyout boom of the 1980s was conceived in the 1960s by a number of corporate financiers, most notably Jerome Kohlberg, Jr. and later his protégé Henry Kravis.

What happens to cash in an LBO? ›

In a leveraged buyout, or LBO, the acquiring firm or entity uses the cash and other highly liquid securities on the target's balance sheet to pay off the debt from the acquisition. This is one reason companies like to keep cash and other marketable securities low as reported on the balance sheet.

Why is LBO considered the floor? ›

To recap, a LBO model is often called a “floor valuation” as it can be used to determine the maximum purchase price the buyer can pay while still reaching the fund specific returns thresholds.

Is a leveraged buyout like a mortgage? ›

The most common analogy used to explain an LBO is: “Buying a house with a cash down payment and a mortgage.” But that is a misleading way to think about it – because an LBO is more like buying a house to rent out to *tenants* i.e. an asset that you earn cash flow from, as opposed to a place to live in yourself.

What is the difference between M&A and LBO? ›

As the name suggests, LBOs use leverage, or debt, to finance a large part of the purchase price. Unlike an M&A model where the acquirer is often a strategic buyer, the private equity firm is more return-driven, and the LBO model is, therefore, more focused on the Internal Rate of Return (IRR) of the transaction.

What are 6 types of financial models? ›

Top 10 types of financial models
  • Three-Statement Model.
  • Discounted Cash Flow (DCF) Model.
  • Merger Model (M&A)
  • Initial Public Offering (IPO) Model.
  • Leveraged Buyout (LBO) Model.
  • Sum of the Parts Model.
  • Consolidation Model.
  • Budget Model.
Sep 26, 2022

What are the 4 valuation methods? ›

4 Most Common Business Valuation Methods
  • Discounted Cash Flow (DCF) Analysis.
  • Multiples Method.
  • Market Valuation.
  • Comparable Transactions Method.

How long does an LBO take? ›

Basic LBO Modeling Test – A relatively easy practice test that usually takes around 45 minutes (and an hour at most).

Why would a company do a leveraged buyout? ›

The purpose of an LBO is to allow a company to make a major acquisition without committing a lot of capital. In the most typical leveraged buyout example, there is a ratio of 90% debt to 10% equity.

Why is DCF value higher than LBO? ›

With a DCF, by contrast, you're taking into account both the company's cash flows in between and its terminal value, so values tend to be higher. Note: Unlike a DCF, an LBO model by itself does not give a specific valuation.

Is LBO an M&A? ›

An LBO is often carried out as part of a mergers and acquisitions (M&A) strategy. Sometimes, LBOs are also used to acquire competitors and enter new markets to allow a company to diversify its portfolio. But business people and private equity firms very often opt for an LBO due to the tax aspects.

How do junk bonds work in an LBO? ›

Bonds issued for LBOs are often considered to be junk bonds because they are very risky; if the company issuing the bonds goes bankrupt, since the bondholders have low priority during liquidation they often will lose all their money.

How is IRR calculated in LBO? ›

So the rule of thumb is that, for “double your money” scenarios, you take 100%, divide by the # of years, and then estimate the IRR as about 75-80% of that value. For example, if you double your money in 3 years, 100% / 3 = 33%. 75% of 33% is about 25%, which is the approximate IRR in this case.

Is MBO a LBO? ›

A management buyout (MBO) is a corporate finance transaction where the management team of an operating company acquires the business by borrowing money to buy out the current owner(s). An MBO transaction is a type of leveraged buyout (LBO) and can sometimes be referred to as a leveraged management buyout (LMBO).

What does MBO stand for? ›

Management by Objectives, otherwise known as MBO, is a management concept framework popularized by management consultants based on a need to manage business based on its needs and goals.

How do you finance a buyout? ›

You can finance a partner buyout in many ways—using a partner buyout loan, your own funds, or by selling your partner's shares in the business to investors. Because partner buyouts are often expensive, partner buyout loans are a popular option for small business owners who need to buy out their partner(s).

What is the largest LBO in history? ›

The Most Famous Leveraged Buyouts (LBOs) in History
  • RJR Nabisco (1989): $31 billion.
  • McLean Industries (1955): $49 million.
  • Manchester United Football Club (2005): $790 million.
  • Safeway (1988): $4.2 billion.
  • Energy Future Holdings(2007): $45 billion.
  • Hilton Hotels (2007): $26 billion.
  • PetSmart (2007): $8.7 billion.

What is an example of management buyout? ›

One particularly well-known example of a management buyout came in 2013, when Michael Dell, founder of the eponymous computer company, paid $25 billion to take it private, with the help of a private equity firm.

Can anyone do a leveraged buyout? ›

In principle, a buyer can acquire a business with 'no money down' if the seller's asking price is lower than the value of the company's assets. For this strategy to work, the seller has to sell the company for 90% of the assets value (or less).

Why would you use leverage when buying a company? ›

Investors use leverage to multiply their buying power in the market. Companies use leverage to finance their assets—instead of issuing stock to raise capital, companies can use debt to invest in business operations in an attempt to increase shareholder value.

Is LBO hostile takeover? ›

LBOs are also commonly known as hostile takeovers because the management of the targeted company may not want the deal to go through. Leveraged buyouts tend to occur when interest rates are low, reducing the cost of borrowing, and when a particular industry or company is underperforming and undervalued.

Who invented leveraged buyout? ›

In fact, it is Posner who is often credited with coining the term "leveraged buyout" or "LBO." The leveraged buyout boom of the 1980s was conceived in the 1960s by a number of corporate financiers, most notably Jerome Kohlberg, Jr. and later his protégé Henry Kravis.

Is Twitter a LBO? ›

That's the key to almost all of the LBOs, or leveraged buyouts, that have dominated mergers and acquisitions for a generation. But while Elon Musk's $44 billion planned takeover of Twitter is an LBO, it differs from most in several important respects.

What is the most common challenge with a management buyout? ›

Difficulties of Raising Funding

In many cases the current management team are not able to raise enough capital to fund an MBO themselves. This is generally due to lack of personal wealth and/or the business experience required to raise high enough levels of personal funding.

How do you structure a management buyout? ›

How does a management buyout (MBO) work?
  1. The owner(s) wish to sell all or a part of the business.
  2. Members of the existing management team – C suite, board seats, employees – choose to buy the business.
  3. Buyer and seller agree the sale price. ...
  4. The management team assesses the amount they can invest.
Aug 24, 2022

Why would owners want a management buyout? ›

A management buyout is a transaction where a company's management team purchases the assets and operations of the business they manage. MBOs generally occur to take companies private in an effort to streamline operations and improve profitability.

Why is leveraged buyout bad? ›

The risks of a leveraged buyout for the target company are also high. Interest rates on the debt they are taking on are often high, and can result in a lower credit rating. If they're unable to service the debt, the end result is bankruptcy.

What makes a good LBO candidate? ›

What Makes a Good LBO Candidate? LBO Candidates are characterized by strong, predictable free cash flow (FCF) generation, recurring revenue, and high profit margins from favorable unit economics.

How much is LBO debt? ›

LBO Overview

Generally speaking, the debt will constitute a majority of the purchase price—after the purchase of the company, the debt/equity ratio is typically around 2.0x or 3.0x (i.e., usually the total debt will be about 60-80% of the purchase price).

What is the true cost of buying a company in a leveraged buyout? ›

"What is the true cost of buying a company in a Leveraged Buyout? Answer Choices: 1) Its Enterprise Value.

What is leverage with example? ›

When people take out a loan to purchase an asset or with the hopes of growing their money in the future, they are using leverage. For instance, if you take out a loan to invest in a side business, the investment you pour into your side business helps you earn more money than if you didn't pursue your venture at all.

Why does leverage increase IRR? ›

Because debt is cheaper than equity. As a result, all else being equal, the more debt you use in a transaction, the higher your internal rate of return (“IRR”).


1. What is an LBO: Leveraged Buyout
(Corporate Finance Institute)
2. Simple LBO Model - Case Study and Tutorial
(Mergers & Inquisitions / Breaking Into Wall Street)
3. Interview Answer - What Is A Leverage Buy Out (LBO)
(Naasir Ramjaun)
4. The LBO Model: Learn to Value Any Business Like a Private Equity Pro
(Jon Taylor)
5. LBO Model Interview Questions: What to Expect
(Mergers & Inquisitions / Breaking Into Wall Street)
6. CFA Level 2 | Alternative Investments: The Leveraged Buyout (LBO) Model
(Fabian Moa, CFA, FRM, CTP, FMVA)

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