The History of Leverage Buyout. By Robin Trehan Monday, 4th December 2006
There are so many business terms out there: merger - buyout - takeover - with all that language a common person needs a personal size dictionary just to stay on top of the business world.
For that reason, what is a leveraged buyout LBO? A fancy business term in that one company uses a very large amount of borrowed money to meet the cost of acquisition. The assets of the company being purchased are used for collateral of the loans as well as the assets of the company itself. The reason for leveraged buyouts is that it allows companies to make large acquisitions without having to make the commitment of a lot of capital. The ratio is usually 70% debt to 90% with 10% - 30% of it being equity. Because this is not a high ratio, the bonds are usually referred to buy investors as junk bonds.
Although in the 21st century leveraged buyouts are not heard of as they once have been, they do still happen. And in the 1980s Leveraged buyouts had an infamous history, in the 80’s several prominent buyouts led to the eventual bankruptcy of the acquired companies. Because of the knowledge that the leverage ratio was nearly 100% and the interest payments were so huge, many company's operating cash flows were not able to meet the contract.
With that said, LBO’s can be traced back as far as the late 1960s however, then the acquisitions were called "bootstrap" transactions, and very much seen by Victor Posner's take over of Sharon Steel Corporation in the late 60s.
The industry was created by business men such as Jerome Kohlberg while working on Wall Street in the 1960s and 1970s and pioneered by the firm he helped found with Henry Kravis, Kohlberg Kravis Roberts & Co. (KKR). Again this company, KKR will come be known as the largest LBO in the mid 2000s. This year, it was reported by the Washington Post that KKR, Bain & Co. and Merrill Lynch paid nearly $33 billion for an acquisition. It is considered to be extremely ironic that the company’s success can be used later against itself as collateral by a considerable hostile company that seeks to acquire the business.
KKR was credited by Harvard Business School as completing what is called to be the first leveraged buyout in business history through the acquisition of Orkin Exterminating Company in the 1960s. With that said, in the spring of 1955, the first LBO may have been the purchase by McLean Industries Waterman Steamship Corp. McLean borrowed $42 million and raised an additional $7 million through issues of preferred stock. When this deal was finally made, about $20 million of Waterman’s cash and assets were used to payoff an equal amount of debt. With the explanation of leverage buyout’s it can be better understood when people discuss certain takeovers what they are really taking about.
Robin C. Trehan is an expert in the filed of mergers and acquisitions and private equity capital. He can be reached at email@example.com
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