Leveraged Buyout (LBO)

The purchase of a company financed largely with debt placed on the acquired company, which repays it from its own cash flow.

Example

A company bought for 200,000,000 using 120,000,000 of debt and 80,000,000 of fund equity.

The debt magnifies both gains and losses on the equity, and a modest decline in profits can wipe the equity out.

Leverage — Investing with borrowed money so that you control more of an asset than your own capital would buy. Gains and losses are both multiplied by the same factor.
EBITDA — Earnings before interest, tax, depreciation and amortisation - in practice, operating profit with the depreciation and amortisation charge added back.
Covenant — A promise written into a bond contract that limits what the issuer may do while the debt is outstanding - additional borrowing, dividends, asset sales, or a minimum level of interest cover.

Buying a whole company, mostly with somebody else's money — A private equity fund buys control of established companies, usually financing much of the price with debt the company itself must repay. (9 min)
Three engines: profit growth, debt paydown and a higher exit multiple — Buyout returns come from growing earnings, using cash flow to repay debt, and selling at a higher valuation multiple - and only the first is reliably within the manager's control. (13 min)