LBO: whose money buys the company and whose balance sheet pays for it

A leveraged buyout (LBO) is a transaction in which the buyer acquires control of a company largely with borrowed money, while the assets and cash flow of the acquired company itself become the collateral for that debt and the source of its repayment. There is one key distinction here: the debt is not taken on by the seller, nor, in substance, paid by the buyer out of its own pocket — the debt ends up on the target's balance sheet. The equity of the fund or the management team covers only part of the price; the rest comes from banks and bondholders, and these obligations will be serviced from the operating profit of the acquired business.

Mechanics: where the debt sits after closing

The standard structure starts with the creation of a special purpose acquisition vehicle (SPV). The investor's equity is injected into it, and the loans are raised and the debt issued at the same level. The SPV buys the target's shares, after which comes the step the whole structure was built for: the SPV merges with the acquired company, or the liabilities are moved down the structure — a technique known in industry jargon as debt pushdown. From that moment on, the acquired business services the loan taken out to buy it.

This also explains how targets are selected. An LBO suits a company with stable, predictable free cash flow, low initial leverage, tangible assets that can be pledged and limited capital expenditure needs. A volatile commodity play or a cash-burning growth company breaks down in such a structure at the very first interest payment. Initial leverage and the resilience of cash flow can be assessed from issuers' published financial statements — that is where you can see whether, after servicing existing obligations, there is headroom left for new debt.

What the financing structure is made of

The debt portion is almost never uniform. A senior secured bank loan is the cheapest layer and the one with the most demanding covenants. Above it sits bond debt, often high-yield, without hard collateral and with a longer maturity. The mezzanine tier is more expensive still and frequently carries an option to participate in the equity — it bridges the gap between what the banks are willing to lend and what the investor is prepared to put in from its own funds. The structure and ranking of these layers are easiest to examine on the live corporate debt market, where the difference in required yield between a secured and a subordinated issue is directly visible.

Covenants in such a structure are no formality. Limits on maximum leverage, interest coverage, asset disposals and dividend payments determine what the new owner is actually allowed to do with the company. A covenant breach shifts the deal into negotiations with creditors, and this is also where the issuer's toolkit comes in: early redemption, an issuer bond buyback, and restructuring of terms.

Where the returns come from and why leverage cuts both ways

The economics of an LBO rest on several sources: paying down debt from cash flow (the shareholder's share of the company's value grows even if the value itself does not), operational improvements, and a change in the valuation multiple by the time of exit. Leverage magnifies the result from each of them — and magnifies losses in exactly the same way. When operating profit falls, the investor's equity is wiped out faster than it would be in a company without debt suffering the same decline, because interest is paid first and does not depend on market conditions.

The exit from the deal takes place through a sale to a strategic buyer, a stock market listing or a secondary LBO — a resale to another fund with new debt. A separate option is a recapitalisation: the company raises debt and passes the money to the shareholder. Mechanically, this is close to what public companies do through payouts to their owners, and it is worth comparing the logic here with share buybacks as an alternative to dividends.

What this means for a minority shareholder in a public company

When the target is a listed company, the deal goes through procedures that directly affect small shareholders. Crossing the control threshold set by Article 84.2 of the Joint Stock Companies Law obliges the acquirer to make a mandatory offer to the remaining holders — in effect, a tender offer. Further consolidation opens the way for the acquirer to carry out a squeeze-out under Article 84.8, while a reorganisation or major transactions give the shareholder the right to demand a buyback of their shares under Article 75. The final step is often a departure from the exchange, at which point the delisting buyback procedure applies.

The practical effect for the remaining minority shareholders, if the buyout was not complete: higher leverage, a covenant ban on dividends and a change in priorities — cash flow goes to creditors. It makes sense to track corporate decisions on such deals through the events calendar.

The Russian specifics

Classic LBOs occur noticeably less often in Russia than in the US or Europe, and the reason is structural: a limited high-yield corporate debt market, the cost of bank funding, lenders' caution about share pledges and the general sensitivity of deals to interest rates. Hybrid forms are more common — a management buyout with moderate leverage, or a deal with a substantial share of the buyer's own equity. The platform's database holds no statistics on the volume and structure of such deals, so we give no quantitative estimates for the Russian market here — any figures at this point would be guesswork.

It is also worth distinguishing an LBO from mechanisms that look similar on the surface: a buyback programme and open-market repurchases are ways of allocating capital within an existing company without a change of control, whereas an LBO changes the owner. Defence against an unwanted bidder through a friendly acquirer is covered separately — in our piece on the white knight. Terminology for related procedures is easy to check in the glossary.