and the ability of the company to cover those costs. Typically the debt portion of a LBO
ranges from 50%-85% of the purchase price, but in some cases debt may representupwards of 95% of purchase price. Between 2000-2005 debt averaged between 59.4%and 67.9% of total purchase price for LBOs in the United States.
To finance LBO's, private-equity firms usually issue some combination of syndicatedloansandhigh-yield bonds. Smaller transactions may also be financed with mezzanine
debt from insurance companies or specialty lenders. Syndicated loans are typicallyarranged by investment banks and financed by commercial banks and loan fundmanagers, such as mutual funds, hedge funds, credit opportunity investors and structuredfinance vehicles. The commercial banks typically provide revolving credits that provideissuers with liquidity and cash flow while fund managers generally provided funded termloans that are used to finance the LBO. These loans tend to be senior secured, floating-rate instruments pegged to the London Interbank Offer Rate(LIBOR). They are typically
pre-payable at the option of the issuer, though in some cases modest prepayment feesapply.
High-yield bonds, meanwhile, are also underwritten by investment banks but arefinanced by a combination of retail and institutional credit investors, including high-yieldmutual funds, hedge funds, credit opportunities and other institutional accounts. High-yield bonds tend to be fixed-rate instruments. Most are unsecured, though in some casesissuers will sell senior secured notes. The bonds usually have no-call periods of 3-5 yearsand then high prepayment fees thereafter. Issuers, however, will in many cases have a"claw-back option" that allows them to repay some percentage during the no-call period(usually 35%) with equity proceeds.Another source of financing for LBO's is seller's notes, which are provided in some cases by the entity as a way to facilitate the transaction.The acquisition of another company using a significant amount of borrowed money(bonds or loans) to meet the cost of acquisition. Often, the assets of the company beingacquired are used as collateral for the loans in addition to the assets of the acquiringcompany. The purpose of leveraged buyouts is to allow companies to make largeacquisitions without having to commit a lot of capital.
:In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this highdebt/equity ratio, the bonds usually are not investment grade and are referred to as junk bonds. Leveraged buyouts have had a notorious history, especially in the 1980s whenseveral prominent buyouts led to the eventual bankruptcy of the acquired companies.This was mainly due to the fact that the leverage ratio was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet theobligation.