What is a Leveraged Buyout?

A leveraged buyout is a tactic through which control of a corporation is acquired by buying up a majority of their stock using borrowed money. It may also be referred to as a hostile takeover, a highly-leveraged transaction, or a bootstrap transaction. Once control is acquired, the company is often made private, so that the new owners have more leeway to do what they want with it. This may involve splitting up the corporation and selling the pieces of it for a high profit, or liquidating its assets and dissolving the corporation itself.

The concept of the leveraged buyout originated sometime in the late 1960s, and for the first decade of its existence, it remained relatively obscure and quiet. In the 1980s, Congress began examining the practice closely for legislation, and the media devoted an enormous amount of attention to high-profile cases. By the late 1990s, it was declared that the tactic was a dead one. With the advent of the "New Economy" and seemingly never-ending highs for the market, it appeared that this type of buyout would remain a historical artifact. Since the dot-com collapse, however, the tactics appear to be making a comeback, albeit in a slightly revised format.

Some historic examples of successful leveraged buyouts may help to demonstrate the tactic. In 1982, the company Gibson Greeting Cards was acquired by a financial group headed by Wesray Capital for a purchase price of $80 million US Dollars (USD). The financial group itself put in only $1 million USD, borrowing the rest in junk bonds. Upon acquisition, the group turned Gibson Greeting Cards into a privately held corporation. A year and a half later, in the midst of a bull market, they went public with the company again. The total value of the company at this point was $220 million USD. One of the principle architects of the buyout, William Simon, who had initially invested $330,000 USD, received $66 million USD from the final transaction.

At its peak in 1989, total revenue in transactions for these buyouts was just over $76.6 billion USD. With fairly low risk and the potential for enormous profit, it is not surprising that the strategy was so popular during the ideal market conditions of the 1980s. Perhaps the most popular story of such a buyout is that related in the book Barbarians at the Gate by John Helyar and Bryan Burrough, about the hostile takeover of the Nabisco corporation.

In the wake of the surge of leveraged buyout tactics during the 1980s, a number of precautionary measures were conceived by corporations to make themselves less vulnerable. The most famous of these is the poison pill, a method by which the corporation destroys itself if it is taken over. By ensuring that valuation would fall dramatically in the event of a takeover, corporations remove any incentive for buyout firms to target them.