Leveraged buyout analysis is based on the assumption that a company will be purchased by private investors and the company will become privately held. The buyout will be paid for with debt and private equity.
Acquiror will raise the highest allowable levels of debt (given the target credit ratings and the market appetite for the company’s debt) such that the equity investors contribute the minimum amount of equity practicable, thereby maximizing equity returns.
The LBO value of the company is the maximum offer price at which the equity investor earns his minimum required equity return. In today’s market, most private equity investors require an annual equity return between 1 5 and 30 percent. Historically, private equity investors would only consider transactions with an annual equity return greater than 25 percent.
LBO analysis is often used to determine the “ﬂoor” value for a company since it represents what a ﬁnancial buyer would be willing to pay. Since strategic buyers are usually able to generate more synergies than a ﬁnancial buyer and since strategic buyers tend to have lower return requirements than ﬁnancial buyers, strategic buyers are generally able to pay more for the same company than a ﬁnancial buyer.