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16.3 What are the advantages and disadvantages of LBOs and MBOs?

A leveraged buyout or LBO is a type of aggressive business practice whereby investors or a larger corporation utilizes borrowed funds (junk bonds, traditional bank loans, etc.) or debt to finance its acquisition. The assets of the acquiring corporation and acquired company functions as a form of secured collateral in this type of business deal.

The advantages of LBO’s are as below:

1. LBO’s helps the poorly managed firms to undergo corporate reformation by changing their corporate structure. This way a company can re-vitalize itself and earn substantial results.

2. Since the leveraged buyout involves high debt to equity ratio, larger firm can acquire smaller firm with very little capital.

3. Stockholders of the company can benefit from the higher financial provided that the returns of the acquired firm are greater than the cost of financing. In such a case the value of the firm would be increased.

4. MBO’s can prevent a company from being acquired by external sources or from being shut down completely.

5. Since the management understand and have been involved in the running of the business to be acquired, the commercial due diligence that is usually undertaken when a company is acquired should be easier and less time-consuming.

The disadvantages of LBO’s are as below:

1. Corporate restructure, arising out of LBO can greatly impact the employees of the company. This occurs usually when a firm has to be downsized as a result of LBO and have to reduce the number of paid staff, which would result in unemployment. This might overall affect the community in the broader sense.

2. If the returns of the company are turns out to be less than the cost of debt-financing, then the situation might result in corporate bankruptcy. The higher interest rates might create a challenge to the companies whose cash flow and sales of assets are insufficient.

3. MBO’s can...