What Is a Leveraged Buyout (LBO)?
A leveraged buyout is the purchase of a company using a significant amount of debt, often 50% to 70% of the total purchase price, with the buyer contributing the rest as equity. The acquired company's cash flows are then used to pay interest and gradually repay the debt over the holding period.
LBOs are the core strategy of private equity firms, which buy companies, improve their operations, pay down debt, and sell them several years later. The most famous LBOs, like the giant buyouts of the late 1980s and mid-2000s, involved household-name companies taken private for tens of billions of dollars.
How the Math Works
Consider a private equity firm that buys a company for $500 million using $300 million of debt and $200 million of its own equity. Over five years, the company uses its cash flow to pay debt down to $150 million, and the firm sells the business for $700 million.
At exit, the equity is worth $700 million minus $150 million of remaining debt, or $550 million, compared to the $200 million invested, a 2.75x multiple of invested capital. Leverage amplified the return: the company's total value grew 40%, but the equity nearly tripled.
What Makes a Good LBO Candidate
Because debt must be serviced, ideal LBO targets have stable, predictable cash flows, low capital expenditure needs, and defensible market positions. Cyclical or capital-hungry businesses are riskier because a downturn can leave them unable to cover interest payments, which is how leveraged deals end in bankruptcy.
The debt itself typically comes in layers, from senior bank loans at the top of the capital structure to riskier high-yield bonds or mezzanine financing below. Buyers also look for operational improvements, add-on acquisitions, and multiple expansion as additional sources of return beyond debt paydown.
LBOs in Banking and Interviews
Investment banks participate in LBOs by advising targets and sponsors, arranging the debt financing, and underwriting the loans and bonds that fund the deal. Leveraged finance and financial sponsors groups exist largely to serve private equity clients doing these transactions.
The paper LBO, a simplified buyout model done mentally or on paper, is a staple of private equity interviews, and banking interviews frequently ask what makes a company a good LBO candidate.
