How are leveraged buyouts financed?

A leveraged buyout (LBO) is a transaction in which the buyer borrows a significant portion of the requisite funds to purchase the specified asset from the seller. LBOs are often executed by private equity groups. When the existing ownership of a business is looking to exit, it often finds willing buyers among private equity firms.

In addition to the equity provided by the private equity sponsor, buyers often use borrowed funds to comprise the total purchase price when executing a buyout. A key feature of an LBO is that the borrowing takes place at the company level, not with the equity sponsor. The company that is being bought out by a private equity sponsor essentially borrows money to pay out the former owner.

A private equity sponsor often uses borrowed funds from a bank or from a group of banks called a syndicate. The bank structures the debt (revolving, term debt or both) in various tranches and lends money to the company for working capital and to pay out the exiting ownership.

Bonds and private notes can be a source of financing for an LBO. A bank or bond dealer acts as an arranger in the bond market on behalf of the company being sold, assisting the company in raising the debt on the public bond market.

Subordinated debt (also called mezzanine debt or junior debt) is a common method for borrowing during an LBO. It often takes place in conjunction with senior debt (bank financing or bonds as described above) and has features that are both equity-like and debt-like.

Seller financing is another means of financing an LBO. The exiting ownership essentially lends money to the company being sold. The seller takes a delayed payment (or series of payments), creating a debt-like obligation for the company, which, in turn provides financing for the buyout.