Who bears the debt in an LBO?

Who Bears the Debt in an LBO?

In a leveraged buyout (LBO), the acquired company incurs the majority of the debt burden. The acquiring firm utilizes borrowed capital to fund the acquisition, collateralizing the loan with the target company’s assets. As a result, the acquired entity becomes liable for servicing the significant debt incurred during the transaction.

Mechanism of LBO Debt Allocation

LBOs are characterized by a high degree of leverage, meaning the acquiring firm relies heavily on borrowed funds. This debt is often structured as a combination of senior secured loans, junior subordinated loans, and high-yield bonds.

The target company’s assets serve as collateral for the senior secured loans, which are typically provided by banks and other financial institutions. These loans have a higher priority in the event of default, meaning they will be repaid before other forms of debt.

Junior subordinated loans and high-yield bonds are riskier investments and, thus, carry higher interest rates. These loans are typically provided by private equity funds and hedge funds. They are subordinated to senior secured loans in the event of default, meaning they will be repaid only after the senior loans have been satisfied.

Consequences for the Acquired Company

The substantial debt incurred in an LBO places a significant financial burden on the acquired company. The company must generate sufficient cash flow to service the debt payments, which can limit its ability to invest in growth and expansion.

Moreover, the high debt levels can increase the company’s risk profile and make it more vulnerable to economic downturns. If the company is unable to meet its debt obligations, it may face bankruptcy or liquidation.

Conclusion

In a leveraged buyout, the acquired company assumes the primary responsibility for repaying the substantial debt incurred during the transaction. The company’s assets are collateralized to secure the loan, and the company’s cash flow is used to service the debt payments. This can place a significant financial burden on the acquired company, limit its investment opportunities, and increase its risk profile.