The Leveraged Buyout (LBO) Guide: Definition & Example

Definition and how it works

An LBO is a transaction in which an investor (often a private equity fund) acquires a company by contributing a portion of equity and raising a significant portion of debt. The key feature: the debt is repaid using the cash flows generated by the acquired company, typically via dividend upstreaming to the acquisition vehicle.

Typical structure

• Creation of an acquisition holding company owned by the investors.
• Equity contribution (often 20 to 30% of the purchase price).
• Debt financing put in place (often 70 to 80%).
• Acquisition of the target company by the holding company.
• Progressive repayment using cash flows distributed by the target.

Simplified example

A company is valued at €100m. A fund invests €25m of equity and borrows €75m. The company generates €20m of annual cash flow distributed to the holding company, enabling debt repayment. If the company is sold for €150m after 5 years, the capital gain on equity is amplified by leverage.

In short, an LBO relies on a simple principle: using the company’s future resources to finance its own acquisition.

Which companies are best suited to this type of transaction?

In practice, a leveraged buyout works best when the target company has favorable characteristics: a mature business, recurring revenues, and predictable cash generation. Highly cyclical sectors, or those dependent on an unstable market, make the structure more fragile.

Common criteria include:

• regular and relatively resilient cash flows;
• moderate investment needs (capex);
• stable margins (or a realistic improvement plan);
• reasonable initial leverage;
• strong management team and clear governance.

These factors make it easier to arrange sustainable financing and help secure the repayment capacity within the acquisition structure.

Leverage: the engine of returns

Leverage increases equity returns by using debt.

• Without leverage: €100,000 invested, +30% at exit → +€30,000 (30% return).
• With leverage: €20,000 invested + €80,000 of debt → after repayment, the gain can represent +150% on the initial equity.

This multiplier effect explains the appeal of these deals. In return, excessive leverage can weaken the acquired company.

The 3 performance drivers

Beyond financial leverage, performance generally comes from three complementary drivers:

1. Deleveraging: over time, debt decreases thanks to cash flows upstreamed from the target to the holding company, mechanically increasing the share of value attributable to shareholders.
2. Operational improvement: revenue growth, margin expansion, cost optimization, better capital allocation.
3. Multiple expansion at exit: if the market values the company more highly (or if its positioning improves), the exit multiple can increase, boosting the sale price.

This framework helps explain why two deals that look similar on paper can deliver very different outcomes: execution and timing are decisive.

Variants and role in business succession

There are several configurations depending on the business succession context:

• MBO (Management Buy-Out): takeover by the internal management team.
• MBI (Management Buy-In): takeover by an external management team.
• BIMBO: combination of internal + external managers.
• OBO (Owner Buy-Out): the owner sells part of the equity while retaining control (often driven by wealth-planning objectives).
• Build-Up (LBU): growth through successive acquisitions to create a stronger group.

In all cases, the goal is to ensure continuity of ownership and governance while financing a new growth trajectory.

Key steps in a transaction

1. Origination: identifying a target (stable cash flows, growth potential).
2. Negotiation: price and takeover terms.
3. Structuring: the right balance of debt / equity.
4. Due diligence: financial, legal, and operational audits.
5. Creation of the holding company and acquisition of the target.
6. Active ownership: implementing a value creation plan.
7. Exit: sale to a strategic buyer, sale to another investor (including a secondary buyout), or an IPO.

The typical holding period is around 5 to 7 years, although it varies depending on strategy and the economic cycle. The success of an LBO relies as much on rigorous structuring as on the quality of operational execution.

Financing: a mix of debt instruments

Financing is usually hybrid:

• Senior debt: the most secured, moderate cost, first in line for repayment.
• Mezzanine debt: riskier, higher-yielding, sometimes equity-linked.
• Unitranche: “all-in-one” debt, often used in mid-cap deals.
• High yield: high-yield bonds, generally reserved for very large transactions.

Debt and security: an often underestimated point

In this type of structure, lenders typically require security. The target’s assets (and sometimes those of the group) can be pledged as collateral, partly securing the financing. In return, the higher the leverage, the higher the cost of debt may be, as perceived risk increases.

Tax also matters: interest deductibility can improve net returns (depending on applicable rules).

Stakeholders involved

• Private equity funds: capital, governance, strategic steering.
• Banks / lenders: debt financing and credit structuring.
• Management: often invested to align incentives.
• Financial and legal advisors: securing, structuring, execution.

Common use cases: transformation and asset carve-outs

These transactions are not only used for succession: they can also finance a strategic transformation. They are notably found in take-private transactions or in carve-outs, when a business unit is separated from a group to become standalone.

Deleveraging does not rely only on operating cash flows: it can also be accelerated through disposals of non-core assets or the sale of subsidiaries. When properly managed, this approach reduces financial risk and refocuses the company on its core business.

Benefits and risks of an LBO

Benefits

• Potentially high returns thanks to leverage.
• Alignment of interests between investors and management.
• Financial discipline driven by debt repayment.
• Accelerated growth through capital, expertise, and acquisitions.
• A succession solution for owners seeking a well-structured exit.

Key risks to manage

This powerful succession tool comes with specific risks.

a) Financial risks

• Excessive leverage: pressure on liquidity.
• Default risk if cash flows decline.
• Scissor effect: rising rates + economic slowdown.

b) Operational risks

• Poor execution of the strategic plan.
• Internal resistance, complex integrations.
• Dependence on management.

c) Social risks

• Difficult restructurings.
• Deterioration in employee relations if short-term pressure is too intense.

d) Wealth/ownership risks

• In an OBO, poor structuring can lead to loss of control.
• For private investors: low liquidity and a long time horizon.

Value creation and economic impact

Value creation often comes from:

• Organic growth (commercial development, innovation).
• External growth (build-ups).
• Operational optimization (margins, processes, organization).

On a macro level, these transactions can facilitate the transfer of family-owned businesses, reinvigorate mature players, and strengthen competitiveness. Conversely, if the deal fails, leverage can accelerate distress, with a real social impact.

Examples of successes and failures

Successes

Dell (2013): Michael Dell and Silver Lake (with GIC) take Dell private through a leveraged buyout. Once private again, the company revives its PC business and accelerates its transformation through acquisitions (including VMware). In April 2021, Dell announced the VMware spin-off to simplify its capital structure and strengthen its position in hybrid cloud and other growth drivers.

Picard Surgelés: several successful transactions, a growth engine.

Failures

• TXU Energy (2007): a landmark bankruptcy, driven by sector volatility.
• Toys’R’Us: a textbook case of value destruction and the disappearance of a brand.

These examples highlight a key point: everything depends on the resilience of the acquired company and the strategy.

Role in private equity and wealth management

This is one of the most emblematic forms of private equity. For institutions as well as private investors, it can offer diversification and return potential via specialized funds. From a wealth-management perspective, “capital transmission” vehicles make transactions accessible that were once reserved for large institutions.

Conclusion

An LBO is far more than a financial structure: it is a succession tool, a value-creation lever, and an instrument for corporate transformation. When well structured, it can finance a takeover, professionalize governance, and accelerate a growth strategy.

Its effectiveness, however, depends on balance: too much debt weakens the target and can destroy the very value sought. This is why prudent structuring, rigorous operational execution, and long-term aligned steering are essential.

In a context where business succession remains a major challenge, this type of transaction continues to play a central role—both from a wealth and an economic standpoint.