For those who have not come across leveraged buy-outs before, these were very very popular in the 1980s, at a time when stock markets were flying high and takeovers and mergers were all the rage.  Money was also cheap, and lenders were bending over backwards to help corporate raiders with worldwide economies booming.  So how do leveraged buy-outs work?

As the name suggests, raiders who used the leveraged buy-out ideals would take out massive loans against a target companies assets and cash flow projections, paying off the debt as they went along.  While obviously this would have an impact upon short term profitability, with the majority of income going towards paying off what was in many cases millions of dollars worth of debt, there were advantages.  The beauty of these schemes was that for a relatively small initial sum, the raider could borrow many more times that amount using the company’s assets as collateral and maybe even selling off non-core assets.

After the pay back period was over, and the loan had been successfully repaid the corporate raider would have a business which they owned lock stock and barrel, for which they may only have paid a fraction of the value - with the vast loans paid back out of the companies cash flow.  If the theory went perfectly to plan, which it often did, the owner of the business could net hundreds of millions of dollars of assets.

So what went wrong?

As the market was pushing along well, the economy flying high and not a cloud in the sky, up popped the 1987 stock market crash.  Not only were the banks now looking to reign in some of their ill advised loans, interest rates were sneaking higher (adding to the debt burden) and the economy came under pressure (reducing profitability and cash flow).  These were the events which killed the leveraged buy-out market overnight.

While highly successful for many investors in the 1980s, the situation has never been quite the same with leveraged buy-outs.  We have some debt funded buy-outs since then but the banks are more risk averse and there are fewer prime candidates available for leveraged buy-outs.  Are the golden days gone for ever? Who knows……