Chapter 13 - Financing Transactions: Private Equity, Hedge Funds, and Leveraged Buyout Structures and Valuation

Abstract

This chapter discusses how transactions are financed, with an emphasis on the financing, structuring, and valuation of highly leveraged transactions. In a leveraged buyout (LBO), borrowed funds are used to pay for most of the purchase price, with the remainder provided by a financial sponsor, such as a private equity investor group or hedge fund. LBOs can be of an entire company or divisions of a company. LBO targets can be private or public firms. Typically, the tangible assets of the firm to be acquired are used as collateral for the loans. The most highly liquid assets often are used as collateral for obtaining bank financing. This chapter begins with a discussion of the changing face of LBOs and then explains how such transactions often are financed, alternative LBO structures, the risks associated with poorly constructed deals, how to take a company private, how to develop viable exit strategies, and how to estimate a firm's financing capacity. The terms buyout firm and financial sponsor are used interchangeably, as they are in the literature on the subject, throughout the chapter to include the variety of investor groups, such as private equity investors and hedge funds, that commonly engage in LBO transactions. Empirical studies of pre- and postbuyout returns to shareholders also are reviewed. The chapter concludes with a discussion of how to analyze and value highly leveraged transactions and to construct LBO models.