Leveraged Buyout
A leveraged buyout (LBO) is an acquisition in which the buyer finances the majority of the purchase price with debt, using the acquired company's assets and cash flows as collateral, with the goal of generating returns through debt paydown, operational improvement, and eventual resale.
The leveraged buyout is the defining transaction structure of the private equity industry. In a typical LBO, the acquiring private equity firm contributes equity — often 30% to 40% of the total purchase price — while the remaining 60% to 70% is financed through a combination of senior bank debt, high-yield bonds, and mezzanine instruments. The debt is placed directly on the acquired company's balance sheet and is serviced from its operating cash flows.
The mechanics of a leveraged buyout mean that returns to equity investors are amplified by financial leverage. If a company is acquired for $1 billion using $700 million in debt and $300 million in equity, and is sold five years later for $1.5 billion after repaying $300 million of debt, the equity holders receive $800 million on a $300 million investment — nearly a 2.7x multiple without any operational improvement. Debt paydown alone creates equity value, as each dollar of principal retired converts directly into equity value.
Private equity firms target companies with predictable and stable free cash flow, strong market positions, defensible competitive advantages, and tangible assets that can serve as loan collateral. Capital-intensive businesses with volatile cash flows make poor LBO candidates because the debt burden can quickly overwhelm the company in a downturn. Classic LBO targets include established consumer brands, healthcare services, software businesses with recurring revenue, and infrastructure-adjacent companies.
The debt financing in an LBO is structured in tranches with different priority, maturity, and cost. Senior secured term loans from banks carry the lowest interest rate and highest seniority. High-yield bonds (sometimes called junk bonds) sit below senior debt and carry higher yields. Mezzanine debt, convertible notes, or preferred equity bridge the gap between senior debt capacity and the equity check required.
LBO returns are measured through the multiple on invested capital (MOIC) and internal rate of return (IRR). A strong private equity deal targets a 2x to 3x MOIC and a 20%+ IRR over a typical five-to-seven-year hold. These targets drive the entire deal structure, including how much leverage the firm uses, what price it will pay, and what operational improvements management must achieve.