Ultimate Guide to Leveraged Buyouts

August 1, 20236 min read
Ultimate Guide to Leveraged Buyouts
Share on facebookShare on TwitterShare on Linkedin

Key Takeaways

  • A leveraged buyout occurs when a company is acquired with a substantial amount of borrowed money, in the form of loans or bonds.
  • Mature companies in established industries are often preferred by equity firms over newer or more speculative industries for leveraged buyouts.
  • LBOs are frequently part of a mergers and acquisitions strategy and are sometimes used to buy the competition and to enter new industries for diversification.

While leveraged buyouts lost some popularity following the 2008 financial crisis, they are again on the rise. But what are such buyouts and why do they occur? Here is the ultimate guide to leveraged buyouts.

What is a Leveraged Buyout (LBO)?

A leveraged buyout occurs when a company is acquired with a substantial amount of borrowed money, in the form of loans or bonds.

The loans are frequently backed by the assets of both the acquiring company and the company being acquired. The latter is somewhat ironic since LBOs are widely perceived as hostile and predatory. The company being acquired usually does not sanction the acquisition.

While the frequency of large acquisitions dropped after the 2008 financial crisis, LBOs began to increase on a large scale during the COVID-19 pandemic.

Reasons Why Businesses Use LBO

The chief aim of leveraged buyouts is to permit companies to pull off large acquisitions sans the need to pledge a lot of capital. The typical ratio is 90% debt to 10% equity. The main requirement is usually that the acquired company is thriving and growing.

Leveraged buyouts typically take place because:

  • The company seeks to take a public company private.
  • To improve an underperforming company.
  • The company wants to spin off part of an existing business by selling it.
  • The company wants to transfer private property, such as a change in small-business ownership.
  • A desire to acquire the competition to enter new markets and diversify holdings. 

Types of LBO

There are various types of LBOs, including:

  • Management buyout. Here, the company’s current management team buys out the current owner.
  • Management Buy-In. These usually take place when a company is underperforming or undervalued.
  • Secondary. This is a buyout of a buyout, wherein, through an LBO, a PE sponsor takes control of a business. 

Benefits of LBO

The No. 1 advantage of an LBO is that the acquiring company can buy a significantly larger company by leveraging a comparatively small portion of its assets.

By using as little of their own capital as possible, private equity firms can potentially gain a substantial return on equity and internal rate of return, the latter typically targeted at 30% or higher.

Note that while leverage can improve equity returns, there is also increased risk. That is a main reason why LBOs usually target stable companies.

Examples of LBO

The acquisition of Hospital Corp. of America (HCA) in 2006 by Merrill Lynch, Bain & Co., and Kohlberg Kravis Roberts & Co. At the time, the companies put HCA’s value at about $33 billion.

Two years ago, Blackstone Group and other financiers conducted a leveraged buyout of the medical equipment manufacturer Medline, which was valued at $34 billion. 

What Type of Company is a Good Candidate for an LBO?

Mature companies in established industries are often preferred by equity firms over newer or more speculative industries for leveraged buyouts. The most attractive companies for buyouts usually have robust, reliable operations cash flows, high margins, comparatively low expenditures, strong managers, venerable product lines, and workable exit strategies.

What are the Steps in an LBO?

When one company attempts to acquire another, it issues bonds against the assets of both companies. In other words, the assets of the company being acquired can be used as security against it.

To start, the acquiring company produces, on average, a five-year future forecast and calculates for the final period a terminal value. The analysis will be shopped to lenders to gain as much debt as possible, creation of interest and debt schedules.

Subsequently, credit metrics will be modeled to see the amount of leverage the transaction can accommodate. Then, the free cash flow to the sponsor – usually a PE firm — is calculated, and the IRR is determined. That is followed by a sensitivity analysis.  

Such transactions usually take place when a private equity firm borrows up to 80% of the purchase and funds the rest with its own equity.

LBOs, PEs, and Diversification

LBO activity sped up in the 1980s due to the accessibility of junk bonds. The subsequent crash and ensuing regulation led to more private equity (PE) and venture capital deals. With the overcrowding of public markets in recent years, demand for private equity has heightened.

For those with risk tolerance, PE can offer high returns. Because it is an alternative asset – it has low correlation with public markets – PE holdings can mitigate portfolio volatility. One way to enter private equity is through Yieldstreet, a leading alternative investment platform that helps investors generate consistent secondary income.

The platform, on which nearly $4 billion has been invested to date, offers the broadest selection of alternative asset classes available, including opportunities in art, real estate, transportation … and private equity. Yieldstreet’s curated PE offerings have lower minimums and early liquidity options.

A chief reason to invest in private equity is to diversify one’s investment portfolio. Interspersing one’s holdings with alternative assets such as PE can help reduce risk exposure, in addition to protecting against inflation or other economic instability. In fact, diversification is crucial to long-term investment success.

Start Investing Today

Diversify your portfolio with private market investment offerings.

Portfolio Diversification and Alternative Investments

Alternative investments can be a good way to help accomplish diversification. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

An LBO is frequently part of a mergers and acquisitions strategy and are sometimes used to buy the competition and to enter new industries for diversification. When conducted correctly, and with risks considered, LBOs can garner firms better equity returns.

We believe our 10 alternative asset classes, track record across 470+ investments, third party reviews, and history of innovation makes Yieldstreet “The leading platform for private market investing,” as compared to other private market investment platforms.

1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.

3 "Annual interest," "Annualized Return" or "Target Returns" represents a projected annual target rate of interest or annualized target return, and not returns or interest actually obtained by fund investors. “Term" represents the estimated term of the investment; the term of the fund is generally at the discretion of the fund’s manager, and may exceed the estimated term by a significant amount of time. Unless otherwise specified on the fund's offering page, target interest or returns are based on an analysis performed by Yieldstreet of the potential inflows and outflows related to the transactions in which the strategy or fund has engaged and/or is anticipated to engage in over the estimated term of the fund. There is no guarantee that targeted interest or returns will be realized or achieved or that an investment will be successful. Actual performance may deviate from these expectations materially, including due to market or economic factors, portfolio management decisions, modelling error, or other reasons.

4 Reflects the annualized distribution rate that is calculated by taking the most recent quarterly distribution approved by the Fund's Board of Directors and dividing it by prior quarter-end NAV and annualizing it. The Fund’s distribution may exceed its earnings. Therefore, a portion of the Fund’s distribution may be a return of the money you originally invested and represent a return of capital to you for tax purposes.

5 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.

6 The internal rate of return ("IRR") represents an average net realized IRR with respect to all matured investments, excluding our Short Term Notes program, weighted by the investment size of each individual investment, made by private investment vehicles managed by YieldStreet Management, LLC from July 1, 2015 through and including July 18th, 2022, after deduction of management fees and all other expenses charged to investments.

7 Investors should carefully consider the investment objectives, risks, charges and expenses of the Yieldstreet Alternative Income Fund before investing. The prospectus for the Yieldstreet Alternative Income Fund contains this and other information about the Fund and can be obtained by emailing [email protected] or by referring to www.yieldstreetalternativeincomefund.com. The prospectus should be read carefully before investing in the Fund. Investments in the Fund are not bank deposits (and thus not insured by the FDIC or by any other federal governmental agency) and are not guaranteed by Yieldstreet or any other party.

8 This tool is for informational purposes only. You should not construe any information provided here as investment advice or a recommendation, endorsement or solicitation to buy any securities offered on Yieldstreet. Yieldstreet is not a fiduciary by virtue of any person's use of or access to this tool. The information provided here is of a general nature and does not address the circumstances of any particular individual or entity. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of this information before making any decisions based on such information.

9 Statistics as of the most recent month end.

300 Park Avenue 15th Floor, New York, NY 10022

844-943-5378

No communication by YieldStreet Inc. or any of its affiliates (collectively, “Yieldstreet™”), through this website or any other medium, should be construed or is intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice, except for specific investment advice that may be provided by YieldStreet Management, LLC pursuant to a written advisory agreement between such entity and the recipient. Nothing on this website is intended as an offer to extend credit, an offer to purchase or sell securities or a solicitation of any securities transaction.

Any financial projections or returns shown on the website are estimated predictions of performance only, are hypothetical, are not based on actual investment results and are not guarantees of future results. Estimated projections do not represent or guarantee the actual results of any transaction, and no representation is made that any transaction will, or is likely to, achieve results or profits similar to those shown. In addition, other financial metrics and calculations shown on the website (including amounts of principal and interest repaid) have not been independently verified or audited and may differ from the actual financial metrics and calculations for any investment, which are contained in the investors’ portfolios. Any investment information contained herein has been secured from sources that Yieldstreet believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability therefore.

Private placement investments are NOT bank deposits (and thus NOT insured by the FDIC or by any other federal governmental agency), are NOT guaranteed by Yieldstreet or any other party, and MAY lose value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through the website. Investors must be able to afford the loss of their entire investment.

Investments in private placements are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or liquidity concerns. Investments in private placements are highly illiquid and those investors who cannot hold an investment for the long term (at least 5-7 years) should not invest.

Alternative investments should only be part of your overall investment portfolio. Further, the alternative investment portion of your portfolio should include a balanced portfolio of different alternative investments.

Articles or information from third-party media outside of this domain may discuss Yieldstreet or relate to information contained herein, but Yieldstreet does not approve and is not responsible for such content. Hyperlinks to third-party sites, or reproduction of third-party articles, do not constitute an approval or endorsement by Yieldstreet of the linked or reproduced content.

Investing in securities (the "Securities") listed on Yieldstreet™ pose risks, including but not limited to credit risk, interest rate risk, and the risk of losing some or all of the money you invest. Before investing you should: (1) conduct your own investigation and analysis; (2) carefully consider the investment and all related charges, expenses, uncertainties and risks, including all uncertainties and risks described in offering materials; and (3) consult with your own investment, tax, financial and legal advisors. Such Securities are only suitable for accredited investors who understand and are willing and able to accept the high risks associated with private investments.

Investing in private placements requires long-term commitments, the ability to afford to lose the entire investment, and low liquidity needs. This website provides preliminary and general information about the Securities and is intended for initial reference purposes only. It does not summarize or compile all the applicable information. This website does not constitute an offer to sell or buy any securities. No offer or sale of any Securities will occur without the delivery of confidential offering materials and related documents. This information contained herein is qualified by and subject to more detailed information in the applicable offering materials. Yieldstreet™ is not registered as a broker-dealer. Yieldstreet™ does not make any representation or warranty to any prospective investor regarding the legality of an investment in any Yieldstreet Securities.

YieldStreet Inc. is the direct owner of Yieldstreet Management, LLC, which is an SEC-registered investment adviser that manages the Yieldstreet funds and provides investment advice to the Yieldstreet funds, and in certain cases, to retail investors. RealCadre LLC is also indirectly owned by Yieldstreet Inc. RealCadre LLC is a broker-dealer registered with the Securities and Exchange Commission (“SEC”) and a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”). Information on all FINRA registered broker-dealers can be found on FINRA’s BrokerCheck. Despite its affiliation with Yieldstreet Management, LLC, RealCadre LLC has no role in the investment advisory services received by YieldStreet clients or the management or distribution of the Yieldstreet funds or other securities offered on our through Yieldstreet and its personnel. RealCadre LLC does not solicit, sell, recommend, or place interests in the Yieldstreet funds.

Yieldstreet is not a bank. Certain services are offered through Plaid, Orum.io and Footprint and none of such entities is affiliated with Yieldstreet. By using the services offered by any of these entities you acknowledge and accept their respective disclosures and agreements, as applicable.

Investment advisory services are only provided to clients of YieldStreet Management, LLC, an investment advisor registered with the Securities and Exchange Commission, pursuant to a written advisory agreement.

Our site uses a third party service to match browser cookies to your mailing address. We then use another company to send special offers through the mail on our behalf. Our company never receives or stores any of this information and our third parties do not provide or sell this information to any other company or service.

Read full disclosure