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Leveraged buy-out

A form of take-over engineered from within a company either by management or by a minority shareholding group, with or without the backing of institutional investors, banks and finance houses.

Control is sought by making an offer. conditional upon acceptance by sufficient shareholders, whereby high interest stock is offered in exchange for existing equity shares – with the object of obtaining a controlling interest. This stock may be underwritten by the financial institutions supporting the buyout, but there is an increasingly popular technique of offering stock charged on the assets of the target company itself, assets which will not become the property of the offeror until the take-over is completed.

If the buy-out succeeds, then, whichever If the buy-out succeeds, then, whichever consequent upon the scheme will place a heavy burden on future profits. Those instigating the buy-out will usually have ensured that profits in the years immediately following the acquisition will suffice both to pay the interest charge and to protect the value of the equity. The viability of the company in the more distant future will be the worry of those to whom the shares are subsequently and profitably sold. The leveraged buy-out is a technique frequently employed when the object is to obtain control of a particular division of the company only. In that case, once the takeover has been effected the less attractive parts, which may comprise one or more distinct subsidiary companies, will be sold off. This procedure will often be initiated by those who see a prosperous future for the division to be acquired provided that it can be operated as a single unit, free from the encumbrances of the existing company structure. The proceeds from the sale of the unwanted sections of the old company will contribute towards this anticipated prosperity by providing necessary funds for expansion. These golden opportunities are, of course, not always apparent to the original holders of the equity, who will have exchanged their shares for fixed interest stock. though as they now hold stock with a higher yield they are not expected to complain. The newly generated funds may also be used to reduce the future interest burden by redeeming part of the recently issued loan stock. This will have the effect of reducing the long-term cost of obtaining control.

Reference: The Penguin Business Dictionary , 3rd edt.