Leveraged Finance: Risk, Reward, LBO & More

Leveraged buyouts (LBOs) are often called private equity deals today, but they still work the same way. If you're planning to sell your business, it's important to know how debt plays a role in these deals. Private equity firms usually borrow money to buy businesses, which can bring both bigger rewards and risks for you as the seller. In this article, we'll break down how LBOs work, how using borrowed money can affect your sale, and what you should think about before making a deal like this

When businesses are bought and sold, leveraged buyouts (LBOs) are pretty common. Even though “leveraged buyout” sounds like an old term, it’s still used today as part of private equity deals. If you're thinking about selling your business, you’ll probably deal with private equity firms that borrow money, called leverage, to boost their profits.

Key Highlights of Leveraged Buyouts (LBOs)

1. Leverage Still Dominates Private Equity Deals
   Even though the term “leveraged buyout” is used less often, the basic idea remains the same. Private equity firms almost always borrow money to buy businesses. It’s rare to see a deal where they pay entirely in cash or use only their own money. Using leverage is the norm in these kinds of deals.

2. Sellers Sometimes Get Involved in the Leverage
   A key part of an LBO is whether the seller ends up being part of the borrowed money. This can happen with something called a “seller note,” where the seller agrees to get part of the payment later, based on how well the company does in the future. While this can help close a deal, it also puts the seller at risk if the business struggles with the debt after the sale.

3. Debt Adds Risk
   Using borrowed money can create challenges. If the company doesn’t make enough money after the sale to pay back the debt, the lender could take over the business. This would mean the seller loses out on any more payments. It’s important for sellers to understand how the debt could affect the business after the sale and what it means for the money they expect to receive.

4. Magnified Returns—For Better or Worse
   Private equity firms use leverage to increase their profits. By borrowing money, they can invest less of their own cash while still benefiting from the company’s success. But this can go both ways. While leverage can boost gains, it can also make losses worse. Sellers should keep in mind that while buyers want high returns, the use of debt adds risk, so it’s important to carefully consider how much leverage is being used in the deal.

Defining Key Terms in Leveraged Buyouts

Leveraged Buyout (LBO): A type of deal where a company is bought mostly with borrowed money. The company’s assets are often used as collateral for the debt, which creates high financial risk.

Seller Note: This is when the seller agrees to let the buyer pay part of the price later. The money is usually paid back over time and often depends on how well the business performs.

Private Equity: This is when firms raise money from investors to buy businesses. They often use a combination of their own funds and borrowed money to make these purchases.

Selling your business to a private equity firm with a leveraged buyout can be rewarding, but it also has risks. Knowing how these deals work, especially how debt is used, can help you make better decisions. It’s important to think about how the buyer's use of debt could affect your business in the future. Make sure you understand the deal and how it could impact your money before you move forward.