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Leveraged Buyout

Also known as: LBO, Leveraged Buy-Out

Definition

A leveraged buyout is the acquisition of a business financed primarily through borrowed money (typically 70-80% debt), with the purchased company's assets used as security and its cash flow used to repay the loan.

Understanding LBOs is crucial for business owners planning succession strategies, as they enable employees or management teams to purchase businesses even when they lack sufficient personal capital.

What Does Leveraged Buyout Mean?

A leveraged buyout (LBO) describes a financing method where the purchaser contributes 20-30% equity and borrows the remainder through bank loans or specialist lenders. The acquired company's assets serve as collateral, and its future cash flow repays the debt over 5-10 years.

Under the Companies Act 2006, the target company cannot directly provide financial assistance for its own acquisition. The buyer initially borrows the funds, and only after acquisition can the company's assets secure the debt. Directors must comply with the Insolvency Act 1986, particularly section 214 on wrongful trading, which creates personal liability if they continue trading when they know the company cannot pay its debts.

LBOs commonly serve as succession planning tools. For example, David (age 65) owns a £3 million manufacturing company, but his children aren't interested in running it. His three senior managers have £600,000 combined equity. They structure an LBO, contributing their £600,000 (20%) and securing a £2.4 million loan (80%). The company's £450,000 annual cash flow services the debt over eight years.

Business valuation determines fair purchase price and whether the business generates stable cash flow to service debt. If a business carries LBO debt, this reduces net asset value for inheritance tax purposes. Business Property Relief may provide IHT relief on qualifying business assets, but debt affects estate valuation.

Common Questions

"What is the difference between a leveraged buyout and a management buyout?" A leveraged buyout (LBO) is defined by how it's financed—primarily through borrowed capital rather than equity. A management buyout (MBO) is defined by who performs the acquisition—the existing management team. Most MBOs are also LBOs, but not all LBOs are MBOs, as external investors can also conduct leveraged buyouts.

"How does a leveraged buyout affect business succession planning?" A leveraged buyout can be an effective succession planning tool when business owners reach retirement age but cannot find a corporate buyer. Employees or business associates can use LBOs to acquire the business when they have limited equity, allowing the owner to exit while transferring ownership to trusted buyers.

"What are the main risks of leveraged buyouts for UK business owners?" The primary risks include high debt levels that can strain cash flow if the business underperforms, leaving little financial cushion for unexpected challenges. Additionally, excessive leverage may violate directors' duties under the Companies Act 2006 if insolvency becomes inevitable, exposing directors to personal liability.

Common Misconceptions

Myth: Leveraged buyouts are only for large corporations or private equity firms.

Reality: While LBOs are commonly associated with private equity and large corporate acquisitions, they're equally available to small and medium-sized UK businesses. Management buyouts of SMEs frequently use leveraged financing, with managers contributing 10-20% equity. Many UK business owners successfully exit through employee-led LBOs worth £500,000 to £5 million.

Myth: The buyer's personal assets are at risk in a leveraged buyout.

Reality: In a properly structured LBO, debt is secured against the acquired company's assets, not the buyer's personal assets. However, many UK lenders require personal guarantees from the management team, especially for smaller transactions. Additionally, directors can face personal liability under section 214 of the Insolvency Act 1986 if they continue trading while knowing the company cannot pay its debts.

  • Management Buyout: The most common type of leveraged buyout where the existing management team purchases the business, typically using significant debt financing.
  • Business Succession Planning: The broader exit strategy framework within which LBOs operate as one option alongside family transfers and trade sales.
  • Business Valuation: The critical prerequisite process that determines fair purchase price and assesses whether the business can service LBO debt.
  • Company Shares: The legal instruments transferred in an LBO transaction that must be properly addressed in the seller's will.

Need Help with Your Will?

If you're planning a business exit through a leveraged buyout, your will must reflect your succession strategy, address how business assets and debt obligations pass to beneficiaries, and include contingency provisions if the LBO doesn't complete before your death.

Create your will with confidence using WUHLD's guided platform. For just £99.99, you'll get your complete, legally binding will plus three expert guides. Preview your will free before paying anything—no credit card required.

Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.