Leveraged Buyout (LBO)

A leveraged buyout (LBO) is the acquisition of a company in which most of the purchase price is financed with borrowed money rather than the buyer's own funds. The loans are raised against the target's assets and are repaid out of the target's future cash flow, so once the deal closes the company itself carries the debt used to buy it. The buyer is most often a private equity fund, sometimes joined by the company's own managers (a management buyout) or by a sovereign wealth fund.

An LBO is a form of acquisition, and when the target was a listed company it is called a take-private because the shares are removed from the stock exchange. The financing typically combines senior bank loans, high-yield bonds and private credit, ranked by debt seniority, with a slice of equity from the sponsor on top.

Buying a house with a mortgage is the closest everyday comparison. A buyer puts down a deposit, borrows the rest and pays the loan back over time. If the house rises in value, the buyer's small deposit grows into a large slice of equity, because the bank's share stays fixed.

In an LBO the twist is that the "house" pays its own mortgage. The company's profits go to the lenders each year, so the buyer's stake grows as the debt shrinks. If the business stumbles, though, the lenders still want their money, and a firm that could easily have survived a bad year with no debt may be pushed into default.

A sponsor judges an LBO by the money it gets back relative to the equity it put in, usually expressed as a multiple of invested capital and as an internal rate of return. The multiple is:

and the annual return over $n$ years is approximately:

Here MOIC is the multiple on invested capital and $n$ is the holding period in years. Suppose a fund buys a company for $1,000 million, borrowing $600 million and putting in $400 million of equity. Over five years the company uses its cash flow to cut debt to $300 million and is sold for $1,200 million. The fund receives $1,200 million minus $300 million, or $900 million, a multiple of 2.25 times. The annual return is $2.25^{1/5} - 1$, about 17.6 percent. Had the fund paid all $1,000 million in cash, the same sale would have returned only 1.2 times. That gap is the power of leverage, and it works just as strongly in reverse.

Returns come from three sources: paying down debt, growing profits, and selling at a higher valuation multiple than the purchase price. Interest on the debt is usually tax-deductible, which adds value, although the United States since 2018 has generally capped net interest deductions at 30 percent of adjusted taxable income, and the European Union's Anti-Tax Avoidance Directive applies a similar 30 percent of EBITDA limit.

Leveraged buyouts took off in the United States in the late 1970s and 1980s, when firms such as Kohlberg Kravis Roberts (KKR) and the junk-bond market built by Drexel Burnham Lambert made very large deals possible. KKR's buyout of RJR Nabisco, agreed in late 1988 for about $25 billion, became the symbol of the era. Many 1980s deals later failed, and the junk-bond market collapsed when Drexel went bankrupt in 1990.

A second boom came with cheap credit in the mid-2000s. The roughly $45 billion purchase of the Texas utility TXU in 2007 was then the largest LBO; its successor, Energy Future Holdings, filed for bankruptcy in 2014. After the 2008 financial crisis, low interest rates and the growth of private credit funds kept buyout volumes high. In August 2026 a consortium of Saudi Arabia's Public Investment Fund, Silver Lake and Affinity Partners completed its take-private of video-game maker Electronic Arts for about $55 billion, supported by roughly $20 billion of debt, and several news outlets described it as the largest leveraged buyout on record.

Supporters, drawing on work by economists such as Michael Jensen, argue that heavy debt disciplines managers: with interest to pay, there is little spare cash to waste, which addresses agency costs and the principal-agent problem. Sponsors also tie management pay closely to results. Several studies find that bought-out firms improve operating efficiency and productivity.

Critics counter that much of the return comes from tax savings and financial engineering rather than better businesses, and that high debt raises the chance of default in a downturn, with costs falling on employees, suppliers and pension schemes. Practices such as dividend recapitalizations, in which a company borrows more to pay its owners, are cited in debates over asset stripping. Regulators and central banks also watch the build-up of leveraged loans and private credit as a possible source of systemic risk, since much of it sits outside the banking system.

• US SEC: Division of Corporation Finance
• Bank for International Settlements