A Leverage Buy-Out (LBO) is a method of financing acquisitions of interests by using financial leverage.

This technique consists in creating a holding company that will partially finance the acquisition by means of bank borrowing, the debt being paid back out of the purchased company’s dividends. In concrete terms, you form the capital (alone or with a pool of partners) of the holding company with a minimum contribution completed by a bank loan. At the end of each year, the dividends generated by the company taken over are then transferred up to the holding company to redeem the debt (a loan, generally of 6 or 8 years).

Exemple :

For the acquisition of a company worth 100, you form a holding company that funds the 100 by means of a capital contribution of 20 and a bank loan of 80. The holding company thus owns 100% of the capital of the company purchased.
To pay back the loan, the parent or holding company uses the dividends. As LBOs are based on bank borrowings, they rely on:
The ability to secure the confidence of banks or investors: the personality and the financial soundness of the buyers are key factors.
The capacity of the acquired company to make profits: if no dividends are generated, the holding company could go bankrupt.

The medium-term prospects of the acquired company must therefore be carefully analysed, along with its investment needs (debt redemption can hinder its development).

More generally, the capital/debt ratio must be properly calculated having regard for potential profits.

This is currently a highly active market. LBOs account for 45% of sums invested in Europe by financial investors. And for the past 10 years, the Internal Rate of Return (IRR) of these investments has been constantly on the rise.

Three factors explain why the phenomenon of company transfers is so acute:

The population pyramid, which leads many company founders to hand over the control. The expansion of a domestic market to a European scale, leading companies to implement external growth strategies to acquire European status;
The ‘financiarization’ of the economy, which increasingly leads buyers to regard companies as a "product" or an "investment", purchased with a view to securing subsequent capital gains;
Companies engaged in external growth strategies.

Three categories of investors are involved in the LBO market:

Private individuals, such as business executives, often in partnership with financiers (the role of the financiers in the set-up is changing and becoming increasingly predominant);
Financiers, who are focussing more and more on majority LBOs so as to keep control over their withdrawal;
Industrialists, in the form of dividends, the profits made by the purchased company.

The example above clearly demonstrates that by multiplying the return on capital via leverage (purchasing a company worth 100 with an investment of 20), an LBO is a great way to optimise return on equity. In terms of taxation, the savings made on an LBO are equivalent to the amount of interest paid on the acquisition debt, provided the holding company owns at least 95% of the company acquired. We should add that LBOs are becoming increasingly pertinent in a context of growing ‘financiarization’ of the economy.

MBO (Management Buy-Out): acquisition of a company financially involving the in-house management team, with or without leverage.
IBO (Institutional Buy-Out): acquisition of a company by an investment fund, with or without the support of the management.
MBI (Management Buy-In): acquisition of a company financially involving a management team from outside the company, with or without leverage.
BIMBO (Buy-In Management Buy-Out): acquisition of a company financially involving a combined management team consisting of in-house managers and new managers from outside the company, without or without leverage.
LBU (Leverage Build-Up): an MBO or MBI followed by one or more external growth operations partly leverage financed.
OBO (Owner Buy Out): A buyout by the owner as part of an LBO, for economic purposes.