Target Company

Role of LBO in Acquiring Target Company
Name
Institution
Role of LBO in Acquiring Target Company
Leveraged buyout (LBO) can sometimes be used by a private firm to acquire a target company when it has a relatively small initial capital for the acquisition (Barstow, 2018). Using LBO to acquire a company can be likened to using a mortgage to buy an expensive home in which one pays the total amount in installments. Essentially, the LBO process entails a private firm taking a huge loan from a bank to pay for the buyout of a target company. Thereafter, the profit generated from the bought company is used to repay the debt over a long period of time in small amounts (Barstow, 2018). One of the key motivation for using an LBO strategy in acquiring target firms is not necessarily low initial capital but rather the need to reduce financial risk (Stancill, 2018). For instance, a company may notice that acquiring a target company at once will take up to 80% of its finances leaving it at risk of not paying its employees or replenishing stock in the parent company. In such a case, the company may decide to utilize only 20% of its finances and use an LBO to pay for the rest of the remaining acquisition amount.
Since the LBO relies on the profit of the acquired company to repay the loan taken, it means that the acquired company should be able to produce reliable and steady cash flows to ensure interest payments are promptly met (Stancill, 2018). This is particularly important because default in debt payment may lead to repossession of the target company by the bank.

In addition, LBO is used where the target company will not need continuous reinvestment in the future. This implies that all the profits it generates will mainly be used to pay back loans rather than using it for reinvestment hence, ensuring the repayment process is completed in the shortest time possible.
References
Barstow, S. (2018). Acquiring a target with cash on the target’s balance sheet. Retrieved: HYPERLINK “https://smallbusiness.chron.com/acquiring-target-cash-targets-balance-sheet-73927.html” https://smallbusiness.chron.com/acquiring-target-cash-targets-balance-sheet-73927.html
Stancill, J. (2018). LBOs for smaller companies. Retrieved: HYPERLINK “https://hbr.org/1988/01/lbos-for-smaller-companies” https://hbr.org/1988/01/lbos-for-smaller-companies