A business acquisition strategy wherein an entity acquires a company through a combination of funds1
- The PE initial investment, often at a ratio of 10% of purchase price2
- Institutional investors (pension funds, sovereign wealth funds)
- Debt (leverage) from banks and other lenders
Crucially, the acquired company is liable for paying back the debt, not the acquirer. Combined with a limited liability corporation shield, the investors are not saddled with this debt. In fact, a bankruptcy can actually turn a profit for the PE firm.
Dan Davies argued in The Unaccountability Machine that reforming the leveraged by out process will do much to stabilize society. His policy fix is to require that an entity taking control of an operating company be required to guarantee its debts2. This would require new regulations around LLCs, but in this way you remove the moral hazard element of the deal.
There is a positive spin, to a LBO: it completely changes the incentives of the managers of a business. The payment and service of debt becomes the existential priority for a business. This can be clarifying and prevent the business from focusing on things that donât increase profits or prevent a business from being lazy or avoid management graft (if you donât have money to service debt you certainly donât have money for a private jet)2.
1. Ballou, B. Plunder: Private Equityâs Plan to Pillage America. (PublicAffairs, New York, 2023).
2. Davies, D. The Unaccountability Machine: Why Big Systems Make Terrible Decisions â and How the World Lost Its Mind. (Profile Books Ltd, 2024).