Resources / Glossary / Leveraged buyout

Leveraged buyout.

Aka. LBO
All terms

What is a leveraged buyout?

A leveraged buyout is the acquisition of a company in which a large share of the purchase price is funded with borrowed money. The defining feature is that the debt is secured against the target's own assets and serviced by its own cash flow — the company effectively finances its own purchase.

The equity sponsor — typically a private equity fund — contributes a minority of the price as equity and borrows the rest. Because debt is cheaper than equity and magnifies returns on the smaller equity check, leverage is the central engine of LBO economics. The fund's goal is to grow the company and pay down debt, so that at exit the equity is worth a multiple of what was invested.

LBOs work best on companies with stable, predictable cash flows, durable market positions, and modest existing debt — businesses that can comfortably carry the new leverage without breaking under it.

How an LBO actually works

The structure assembles a capital stack and then uses the company's own performance to repay it.

  1. Set the capital structure. The sponsor decides how much equity to contribute and how much debt to raise — often the majority of the price — across senior loans, subordinated debt, and sometimes seller financing.
  2. Acquire the company. A new acquisition entity buys the target; the debt sits on the acquired company's balance sheet, secured by its assets.
  3. Service and reduce debt. The company's operating cash flow pays interest and steadily pays down principal over the hold period.
  4. Improve the business. The sponsor drives growth and margin through a value-creation plan, increasing EBITDA and the company's value.
  5. Exit. The company is sold or taken public; debt repayment plus higher EBITDA means the equity is worth far more than the original investment.

The combination of debt paydown, EBITDA growth, and multiple expansion drives the return — with leverage amplifying the equity outcome in both directions.

Why leverage cuts both ways

Leverage is what makes an LBO powerful and what makes it dangerous. On a small equity base, modest improvements in the business produce outsized equity returns. The same mechanism works in reverse: if cash flow falls short, the fixed debt service can quickly consume the equity and push the company toward distress.

That is why LBO targets are chosen for the stability of their cash flows, not their growth alone. The discipline of the structure — covenants, mandatory amortization, interest coverage — keeps the company on a path to deleverage, but it also leaves little room for error if the operating thesis disappoints.

Frequently asked.

5 questions
01 Why is debt used in a leveraged buyout?

Debt is cheaper than equity and lets a sponsor control a large company with a relatively small equity check. Because returns are calculated on that smaller equity base, leverage magnifies them — a key reason LBOs can produce high returns when they work.

The trade-off is risk: the same leverage amplifies losses if the company underperforms.

02 Who pays back the debt in an LBO?

The acquired company does, out of its own operating cash flow. The debt sits on the target's balance sheet and is secured by its assets, so the business effectively finances its own acquisition.

This is why LBO candidates need stable, predictable cash flows that can reliably cover interest and principal.

03 What makes a good LBO candidate?

Stable and predictable cash flows, a strong and defensible market position, low existing debt, and identifiable opportunities to improve margins or grow. Asset-heavy or recurring-revenue businesses are often well suited because they support more borrowing.

Highly cyclical or capital-intensive businesses with volatile cash flow are riskier, since they may not reliably service the debt.

04 How do sponsors make money in an LBO?

Through three levers: paying down debt over the hold so a larger share of enterprise value accrues to equity; growing EBITDA through operational improvement; and, where possible, selling at a higher valuation multiple than was paid.

Leverage amplifies the equity return generated by all three.

05 What's the difference between an LBO and a normal acquisition?

The difference is the financing. A normal acquisition may be funded largely with cash or equity, while an LBO is funded predominantly with debt secured against the target. The capital structure, not the act of buying, is what makes it leveraged.

That heavy reliance on debt shapes everything else — the type of target chosen, the return model, and the focus on deleveraging during the hold.

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