Investing in Leveraged Buyouts (LOBs): Know the Risks

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Definition of Investment:

When investors buy a company with the combination of small portion of equity and a large portion of debt is known as Leverage Buyouts. Leverage buyouts are a strategy which is used for large acquisition.

Various Ways to invest:

Generally private equity firms handle leverage buyouts by raise capital from institutions or wealthy individuals.

Bank loans, bonds and mezzanine debt are some common source of fund used for leverage buyouts. Bank loans involve money that acquirer get from a bank. Bonds involve with the issuance of debt instrument used to raise fund to acquire a firm. These bonds are often backed by assets or cash flows from acquired firm. These bonds are referred to as “Junk” bonds or high yield debt because they have higher risk of default; as a result it has higher interest rate.

Mezzanine is a complex instrument which is the combination of both stocks and bonds, offering attractive returns to investors as the reward of notable risks. Once the purchase is complete principle and interest is repaid to the bank, bondholders and holders of mezzanine. Repayment may make by cash flows from acquired business; profit comes from breaking up business or selling its components.

An individual investor can buy the bonds issued to back the buyouts that indicate you are interested to take a chance on Junk bonds.

Another option is to buy the stocks in the target company when you get information about possible acquisition. Generally the stocks tend to rise for the information flow, but there is always a risk to collapse the stock if the deal void.