Leveraged Buyout is a process of acquisition in which the acquiring company uses a large amount of borrowed money in order to acquire the other company. The borrowed money is used to bear the cost of the acquisition and it may include bonds and the loans from the third party. The acquiring company can use the assets and other financial reserves of the acquired company to use them as collateral in order to get loan for the process of acquisition. Other than the assets of the acquired company the assets of the acquiring company are also used as collateral to acquire loans. With the help of leverage buyouts the companies can easily acquire another company without spending a large amount of capital and funds. The major objective of leverage buyout is to make acquisition process a bit easier for the companies.
When a process of leverage buyout occur the debt to equity ratio is very high. For example during the process of acquisition there may be 90 percent of debt and only 10 percent of equity. Due to this high debt to equity ratio the bonds that are used for borrowing money are not considered as the investment bonds rather they are tagged as junk bonds. Leverage buyouts are no encouraged by most of the analysts as they may result in the eventual bankruptcy of the acquired company. The reason of bankruptcy was that the leverage ratio becomes equals to 100 percent and the interest payments become so heavy that companies don’t have enough cash flow to pay principle interest payments. Due to this notorious history leverage buyout is considered as a ruthless acquiring tactic.
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