Determinants of Leverage Ratio in Leveraged Buyouts and Its Influence on the Profitability of Enterprises After Buyout

Abstract

This article explores the determinants of leverage ratio in leveraged buyouts (LBO), introducing the definition of leveraged buyouts and their history of development. This paper identifies tangibility of assets, adequacy of cash flows, sources of finance and the macroeconomic condition as the main determinants of companies’ ability to sustain high leverage ratio. After studying the factors affecting the leverage ratio, the paper evaluates the effect of leverage on the post-acquisition profitability of the companies involved in the LBO transaction. The paper features an example of the LBO of H.J. Heinz by 3G Capital and Berkshire Hathaway as a positive mechanism that supports the statement that LBO can provide benefits to the companies through tax shield effect and motivation in more efficient operations. However, there are two sides of a spectrum, the negative mechanism of LBO is shown by the case of the LBO of Toy R Us by Bain Capital, KKR, and Vornado. This prominent negative example demonstrates that the leverage can exert financial pressure on the company that potentially leads to greater financial vulnerability during business or economic downturns.