Anyone aware of the investment banking industry must have heard the term ‘leveraged financing’. Despite substantial risks, it offers lucrative investment opportunities. In recent times, numerous investment banks have financed big-ticket leveraged buyouts, coining the term leveraged finance investment banking. In this article, you will understand in detail what leveraged buyout is and the role of investment banking in leveraged financing.

Understanding Leveraged Buyout

A leveraged buyout is an arrangement in which a company buys another company using borrowed money. The buyout means to purchase, and leveraged means using other people’s money. For instance, if a company worth $20 million decides to buy a company worth $50 million, it will require a lot of debt, known as a leveraged buyout.

One important question is how a company worth $20 million can raise the $50 million required to buy a bigger company. That is when investment banking comes in. Investment banks create different business models for leveraged buyouts. In that, they lend money to the buyers after securing the target company’s assets. Therefore, once the acquisition takes place, the assets of the bigger company remain as collateral with the investment banking until the borrower repays the debt.

Many companies prefer leveraged finance investment banking for various reasons. If the business performs well, the acquiring company earns a handsome profit. However, if the business fails, the acquired company loses its assets instead of the acquirer.

Role of Investment Banking in Leveraged Buyouts

Investment banks have expertise in raising capital, and leveraged buyouts involve large capital amounts. Hence, investment banking has an important role to play in leveraged financing. Below are the details of their function:

Support to Both Sides: Investment banking is engaged on both sides of a leveraged buyout, including the buy and the sell sides. They raise capital for the buyers and help them select the company worth acquiring. For sellers, they help in a company’s correct valuation and finding the highest bidder.

Valuation and Strategizing: Investment banks handle mergers and acquisitions. Hence, they know the methods of valuing companies. Moreover, they have the resources to perform the target company’s credit check. Many times, companies have hidden debt in their balance sheets.

Investment bankers know the company’s existing structures and provide a true picture to the acquirer. They also help evaluate the target company’s business plan and identify cost-cutting opportunities to reduce the debt burden.

Negotiations and Arrangements: Investment bankers usually deal with the target firm’s existing creditors, including commercial banks and bondholders. Some holders decide to stay on, while others demand their money back due to high risks. Investment banking professionals negotiate with such creditors or arrange to pay them back.

Financial Structuring: Investment banking is crucial to deciding the new company’s financial structure. Experts ensure maximum debt usage without letting the cash flow turn negative. Simultaneously, leveraged finance investment banking ensures minimal equity usage, allowing investors to have minimal fund investment.

To sum up, leveraged finance is a specialized field of investment banking and such transactions generate significant funds.