Basic leveraged buyout (LBO) | Stocks and bonds | Finance & Capital Markets | Khan Academy

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The mechanics of a simple leveraged buy-out. Created by Sal Khan.
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Finance and capital markets on Khan Academy: Private equity firms often borrow money (use leverage) to buy companies. This tutorial explains how they do it and pay the debt.
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[@Fashionarily]

Wow! You know everything! Lol Im pretty sure you are the one who taught me Photosynthesis and Cellular Respiration years ago when I was in college. Now I land on this topic years later and you are teaching me this! Amazing! 😂😂

[@cclar777]

Lmao, he taught me calculus back in 2018!!!

[@khanacademy]

@Frostpako Actually most corporate debt is interest only and you pay most or all the principal at once (usually taking out a new loan to pay the principal on the old one). Also, principal payments do not get accounted for on your income statement.

[@fpxdaxbe]

I have thoroughly enjoyed reading your comments, sir. As an 18 year old (accounting) college student trying to make sense of everything financial, I would love to have a smart, good-American advisor like you. Many thanks!

[@rewardx]

You're 28 now. I hope life is going good for you.

[@thosantos88]

Thank you for this very simple explanation!

[@lifecrackaca2022]

This guy teaches just everything. Wow. Great job.

[@LamarFrancis]

Thanks for making it so simple. Wasn't boring. Had colors to coordinate. Great.

[@klothus9960]

thats a really good video, even eleven years latter it can return me some knowledge for me

[@cyrilsurendar738]

Well explained, so simple and concise. Thank you !!

[@dzidzaichidumba5435]

This is how Manchester United F.C was bought, very intresting

[@m.a6141]

CAME TO HERE ALSO FOR THAT

[@AbbasAdejonwo]

Literally just watched a video on how the Glazers bought MUFC and came here to understand the deal structure more😂

[@philiphan6673]

Exactly what brought me here as well lol

[@azzz3709]

Great video. Explains the structure clearly and simply.

[@MatthieuVlogs]

Wow, what a beautiful and concise explanation. It's great to see how LBOs can be so attractive; it's also interesting to note how they can go awry for the purchased company when the income isn't as consistent as previously thought (Toys-R-Us). Thanks for sharing!

[@rahul27668]

Thanks....I was so confused reading this from cfa books...this made LBO Cristal clear

[@JP1234815]

The great thing about it being an LBO is if the business increases it's net income year on year - that will be magnified by leverage!!

[@BushwickSounds]

Wow those final 10 seconds blew my mind lol

[@marcelolopes5684]

Hi, shouldn't we consider the payment structure on this loan? If we consider a 10 year loan, cash flow cushion is negative since the first year. I understand the minimal payment term which would allow such structure is 25 years, isn't it?

[@abdulmuhaimin5861]

wow..well explained ..thank u

[@clay9984]

Great explanation

[@rohitxess1955]

Wow, this is the easiest explanation out there.

[@honggwan.]

Thank you for the video! It was easy to understand.

[@nikkiklijn2722]

thanks that makes sense now!

[@pattipilot]

Thank you for sharing this. I really appreciate your videos. Keep up the great work!!

[@thekraken1000]

American Hero Right here

[@Andrewcoulibaly]

My big question is it true that firms need to disclose financial information to their lender before being approved for leverage for their buyout? Does that disclosure effect their interest rate or how much money is lended for the buyout?

[@tarekalsherif57]

Awesome! Thank you,

[@dimitriskourti2634]

Generally, good basic explanation. Although some things are left out. How you conclude that is a good business deal, if you are left with 400k income and you still have to pay the principal? In how many years you will repay the debt if you assume that you only pay the interest of the loan? But the basic explanation of LBO is ok.

[@Skulluuzz]

I think this is a VERY important question

[@owenconnelly5975]

Very well done

[@jonveals33]

This is a great simple explanation.

[@gauravtejwani2798]

Amazing 🔥

[@Jack7967]

Hmm. OK. That makes sense.(I think; I was a science major so I had to look up most of that) I can see why sal dumbed it down a lot as an introduction video.

[@tteu123]

This. This is awesome.

[@NotMyWillButThineBeDone]

Makes so much sense. Thank you!

[@arghonandi6818]

great video!

[@DataBeach]

Thanks for this clear explanation of LBO. I don't quite think the deal is a good one for you even at 40% RoI in year 1. Your debt to the bank is not just 10% interest but interest + $9m borrowed principal. It would be nice to see future cash flow of the business showing how the $9m gets repaid without hurting the yearly net income of the business.

[@KazenoniKakuremi]

Yes you are right, the problem is when you goto 100% debt, the interest payment wont be the same, as the bank now is taking more risk, because there is no 1M equity buffer to cushion losses

[@jenniferhall-d5r]

Appreciate the breakdown! Just a question on a different topic: I have the OKX Wallet with USDT, and I have the seed phrase. (job priority warm lab border boil monkey manage palace fiber weird ask). How do I go about transferring them to Binance?

[@tushya2088]

What about the principal to be paid to the bank? That is also an expense to me and shouldn’t it be decreased from the income?

[@Nanamahjiyc]

The principal would be the $9MM you borrowed. Principal repayment does not affect net income.

[@KoalaBearWarrior]

Man these are so great! Keep on posting these vids!!!!

[@KazenoniKakuremi]

I am not sure but I think the return may be even higher, as you will need to add back the tax shield you received from the interest payment...someone correct me if I am wrong

[@as3sfv99ew9]

this was pretty helpful - thanks bro, you did it again!

[@ramonandre2969]

THE KEY TO ALL THIS IS PICKING COMPANIES WITH GREAT ASSETS AND GENERATES INCOME..THAT WILL ABLE A SWING LOAN..

[@rjstn9]

great video, very clear thank you

[@ncochran01]

This is pretty interesting, but the problem is if that business starts to decline, the debt/interest becomes a problem right? It seems like we hear about these big deals (purchase of a large chain from equity) and 5 years later the file for bankruptcy. What is the major downfall of the LBO?

[@Vattic2]

Hey! im not good speaking english but your video was useful whatever! :) thx!

[@sumitagarwal3788]

What about the calculating the fee or cost of management fee of target

[@pornpimolwongsiri4672]

Thank you so much!

[@sabreenabdullajirrow7566]

This was amazing thank you

[@pratikthakur3562]

How would they return principal amount?

[@financekid3163]

Excellent introductory video, for anymore looking to learn more about the LBO transaction and how different parties are involved in the transaction, check out the LBO video on my channel. Let me know if you have any questions!

[@richabazgain5847]

The best explanation (y)

[@SabrinAlzahrani]

why do we pay the whole interest rate in year 1, also what about the principle payback?

[@andrecamacho7660]

10% every year .... not 10% of total period of loan

[@M4rtingale]

@Frostpako The terms of the loan can be negotiated and the size of the installments varies from business case to business case. You cannot conclude based on the video whether or not the installments are larger than the net income.

[@Lehmann108]

That is exactly what happens! All assets including pension funds are open to the creditors.

[@MrCrowbarFace]

wow thanks very informative!

[@brucelee2780]

Amazing! Thank you so much!

[@melynimason4216]

Excellent.

[@gkollias14]

what are the total taxes paid before the buyout and after the buyout?

[@Amira6262]

Thanks, Khan:)

[@woo216]

thanks

[@luiohh]

I've always wondered - why it is the target company which is saddled with the debt used to fund the acquisition, and not the purchaser company itself? Shouldn't it be the purchaser who borrows from the bank and adds in some of the purchaser's own money to buy over the target?

[@CAVaidShukla]

It same thing I was thinking throughout the whole video. How it's the debt of the target company when debt is taken by acquiring company.

[@dimitriskourti2634]

@@CAVaidShukla Probably because it is in the definition of LBOs, the target company is used as collateral, under mortgage. The investment itself is the collateral, so it is one evaluated for the loan. The loan is restricted to the target company, limited liability loan(somehow), if something goes wrong, the damages are restricted to the investment only.

[@adamgrimsley2900]

Nice

[@blackjesus9641]

What about paying off the principle? You said revenues are unlikely to grow much.

[@sumitagarwal3788]

Excellent explanation. 400000 return on 1 million being called not so sleepy return

[@MrCruelStreak]

thank you sal ^-^

[@Jack7967]

So, for this example, what kind of principal payment do you think we'd be looking at? I can't imagine it being high enough not to make it worth it because you are receiving an annual income. You'd get back the $1 Mil in a couple of years and from there on would be making money right?

[@kevinesteves5530]

so.. You a a partner in a private equity fund and you are looking at a BASIC leveraged buyout video.. Must be a very good partnership..

[@KazenoniKakuremi]

yea, you are absolutely right, its the same as 'margin lending' where you borrow a lot of money to trade with, so none of your own equity, but the interest payments are high...if you can find a return that is far greater than those payments, then you can definitely go for a 100% debt financed model

[@andrecamacho7660]

who will finance a 100% your deal ? ... unless you are a known business man.. forget it

[@ups427]

I mean i wish we could get just interest only stuff, but banks don't allow that. in theory you could do a deal with all mezzanine rates, but they are 12-15% + warrants so about 20% per year. Thats way to high. Senior debt right now is 4-6*%, so its a drastic difference in cost of capital.

[@samarthsharma6993]

Beautifully explained .... but isn't 1/3rd of 600 k = 200k ?

[@daan2377]

They pay 1/3rd so they keep 2/3rds so 400k

[@inmortal009]

Wooah amazing

[@scatman0925]

So is the primary pitpose of this just a tax arbitrage???

[@dseer13]

so they liquidate the assets if they turn out they don't have the money to pay back the principal or if the business isnt generating the amount of income one would have hoped? Thats when companys go bust and employees start losing their jobs.

[@neversayjello]

how do credit spreads affect a LBO??

[@M4rtingale]

@TheHumanAgenda (cont'd) 2) A 40% return is better than a 10% return. If you are unable to see this, not even Sal can help you understand. If 10 people lever up their investments, they get a total return among them of 4m, compared to 1m if they did not lever up. Everybody wins!

[@samsonsoturian6013]

Of course, the obvious danger of 10x leverage is that if business slums a little, you is in the hole

[@ntcuong01ct1]

Dear Friends, I have a question: 1/ When and Why we should use LBO (Leveraged Buyout) to do M&A deal?. Thank you.

[@ramajonnalagadda2993]

Lbo’s are generally for private companies, m&a occurs for public securities there is more to it but this is a start

[@TheJoezaidan]

One Question, you don't pay back the $ 9 million loan ?

[@mar79379]

what software do you use to draw?

[@clayandrews4905]

The $400k is not the ROI. It's the firms new net income. So yes there is a 40% return if you are comparing net income over investment, however the investor will only claim a portion of that income if they are interested in growing the firm or refinancing, it may be possible to reach a 40% return after several years if the loan is refinanced and structured to maximize investor earnings potential.

[@xWhiteRice]

This may be 6 months old but I disagree. as a 0 growth firm, all of that net income would theoretically be pushed out as dividends. And as the sole owner, congratulations on your 400k annual payday.

[@Rocksteady365mac]

So what about paying the investment bank back the £9m? I assume it's when you sell the business to another private equity firm and use that money?

[@M4rtingale]

@TheHumanAgenda (con'td) 1.2) The company or investor DO have the available funds, but are unwilling to lock p the money in a single project. As a result, the rest of the money is freed up for other investments or furthering the one already in business. (con't)

[@akhiljohny5483]

Came here after reading about Elon Musk's plan to buy Twitter

[@28gbb]

good explanation but no bank would give you 90% leverage, maybe 50% if you are lucky on a small private company - if it has hard assets.

[@markolivito2167]

But you forgot the principal payments on $9mm loan!

[@mattmatt4916]

What was that at the 2.45-2.47 minute? Some squeezing the Truth in I SEA.. lol

[@ChiChi-sw5iu]

Ghenghis owns this academy 👁👄👁

[@randombarbarian5637]

Maybe I'm missing something here, but did you forget to pay the principle of the loan? This should come out of the $400k/year. You were only calculating the interest payment of the loan.

[@addydaddy1100]

ok... even still if I raised my debt... still I they will leave atleast something to me... the point I am making is none of my equity I have invested.. but I still earn a profit...

[@PedroJardo]

Wait, but why the money goes into the business? Isnt that a Cash out transaction?

[@fleshcookie]

interesting.

[@addydaddy1100]

What if i take whole of the money as loan which is 10 million, I will pay 1 million interest which will be deducted from pretax income leaving 500K. Now if I deduct 1/3rd of the tax which leaves aprrx 360000 as Net Income without even investing a single penny. Correct me if I am wrng.. Just curious if its right..?

[@pslink6437]

Who on earth would buy a business for 10 times EBITDA.

[@chiragpatel849]

just an example

[@SmartyPFc]

Most private equity firms...

[@secondavenger9775]

IBM apparently would for Red Hat...

[@mario34129]

You mean 10 times net income?

[@gkollias14]

net income is not EBITDA

[@eh1114]

ya, but if you already have money why would you want to borrow more money that requires you to pay interest?

[@jxsilicon9]

This is an interesting presentation. But nobody structures leverage buyouts like this. Well not anyone that knows what they're doing. You borrow less than the assets. So you can actually sell the assets to payoff the loan. Or you bring in other investors since banks only lend to about 10% of deals.

[@andrecamacho7660]

who told you that 10% thing ? thats so untrue

[@weeeee880]

Is that you vladtv???!

[@siu281]

So now my slow brain finally understands what the Galzers are doing at Manchester United

[@kevinrrodriguez1706]

Can someone explain what happens to the remaining $9 million owed in this case? I always have difficulty conceptually grasping this part…

[@wronggg]

​@@BlakeRees Completely wrong. You'll be paying $900k in interest PLUS the principle which will be significant too. Your true take home, cash bottom line will be much smaller than this video portrays (although you'll be building equity value too.)

[@shabeelath]

pretax income of 1.5 million only you took there isn't a need of taking another 1 million and 9 million we took? and how did 400 k came please explain it sir

[@harishreddy325]

😍😍😍😍❣️

[@ups427]

hey im a partner in a private equity fund. the idea that lbo senior debt is interest only is 100% false.

[@David-f9z8e]

hey how wealthy are you?

[@jxsilicon9]

@TheHumanAgenda Banks don't like running companies or owning real estate.