A leveraged buyout (LBO) is a technique used by an investor to purchase a company (the target) using three different types of leverage:
Legal leverage: The operation will be structured using a holding company which will purchase shares of the target. As a consequence, controlling 50% of the holding company which owns 50% of the target shares will enable an investor to control the target while having paid for only 25% of its capital. This leverage can be increased by using several successive holding companies.
Financial leverage: The holding company will generally issue a large amount of debt to finance the transaction. Dividends of the target which are paid to the holding company will then be used to service the debt.
Fiscal leverage: Generally, dividends generated by the target and paid to the holding company can be exempt of taxes. Furthermore, if certain criteria are met, the target’s income can be consolidated with the holding company’s income to potentially reduce global income taxes (if the holding’s income is negative).
An LBO is a risky investment which, in general, could last between three and seven years.