What Is a Leveraged Buyout (LBO)? Explained

A leveraged buyout (LBO) is an acquisition financed mostly with borrowed money, where the debt is secured against the target company’s own assets and future cash flows rather than the buyer’s. The acquiring firm — typically a private equity firm — puts up a relatively small slice of equity and finances the rest with loans and bonds that the acquired company itself becomes responsible for repaying after the deal closes. The target company, in effect, ends up financing its own purchase.

How the structure works

In a typical LBO, a private equity firm identifies a company it believes is undervalued, generates stable cash flow, or could be run more efficiently. Rather than paying the full purchase price in cash, the firm contributes a minority of the price as equity and borrows the rest — often the majority of the total — from banks and bond investors. That debt is loaded onto the target company’s balance sheet once the acquisition closes, not the private equity firm’s own books.

This matters because it changes who’s on the hook. Before the deal, the target company might have carried little to no debt. After the LBO, it’s responsible for servicing a large new debt load out of its own operating cash flow — interest payments and principal repayments become a fixed cost the business now has to cover every period, regardless of how the underlying operations are doing.

Why private equity firms use leverage

Borrowing to fund most of the purchase price magnifies returns on the equity actually contributed. If a firm buys a company for a mix of equity and debt, and the company’s value grows before the firm sells it years later, the return on that smaller equity check is much higher than if the firm had paid the full price in cash — because the gain is measured against a smaller base of invested capital. This is the core mechanic of leverage: it amplifies gains on the way up (and, symmetrically, amplifies losses if the deal goes badly).

Beyond the return math, LBOs typically follow a playbook: acquire a company with stable, predictable cash flow (which is needed to service the new debt), take it private so the firm can restructure operations without public market scrutiny, improve margins or growth over a multi-year holding period, and then exit — either by selling to another buyer or taking the company public again through an IPO — to realize the return on the original equity investment.

The risks

The leverage that magnifies returns also magnifies risk, and it’s the acquired company that bears most of it. A heavy new debt load means fixed interest obligations that must be paid regardless of how the business performs. If cash flow falters — from a downturn, competitive pressure, or simple execution missteps — the company can struggle to service its debt, and in the worst cases end up in default or bankruptcy under the weight of an acquisition it didn’t originally choose. LBOs have also drawn criticism when the new ownership responds to that debt burden with aggressive cost cutting, layoffs, or asset sales specifically to generate cash for debt payments rather than to grow the underlying business.

Measuring an LBO target

Private equity firms lean heavily on EBITDA and free cash flow when evaluating LBO candidates, since both are proxies for how much debt the target’s operations can realistically service. A company with strong, predictable free cash flow and modest existing debt is a far more attractive LBO target than one with volatile earnings, since volatile cash flow makes fixed debt payments much riskier to guarantee.

LBO vs a traditional acquisition

	Traditional acquisition	Leveraged buyout
Primary funding source	Buyer’s cash or stock	Debt secured against the target
Who carries the new debt	N/A or buyer’s balance sheet	The acquired company itself
Risk if performance disappoints	Falls mostly on the buyer	Falls mostly on the acquired company
Typical buyer	Strategic corporate acquirer	Private equity firm
Post-acquisition focus	Integration into the buyer’s business	Standalone operational improvement, then exit

Where LBOs fit in the broader capital landscape

LBOs sit alongside venture funding rounds and SAFE agreements as ways capital changes hands to control a company, but they serve a different purpose: venture funding backs early, unproven growth, while LBOs typically target established, cash-generative businesses where the bet is on operational improvement rather than growth from a standing start. A hedge fund might trade the debt or equity of an LBO’d company after the fact, but the deal itself is usually the domain of dedicated private equity firms structuring the acquisition from the outset.

The takeaway

A leveraged buyout funds an acquisition primarily with borrowed money secured against the target company, letting the acquiring firm control the business with a comparatively small equity investment. That leverage magnifies the potential return on the firm’s own capital, but it also transfers real financial risk onto the acquired company, which now has to service debt it didn’t take on for its own reasons. Whether an LBO turns out well depends heavily on whether the target’s cash flow was strong and stable enough to support the new debt load in the first place.