In an LBO, what is meant by "leverage"?

In the context of a leveraged buyout (LBO), "leverage" specifically refers to the use of borrowed capital to finance the acquisition of a company. This strategy allows investors to increase their potential return on investment by amplifying the amount of capital available for the buyout without needing to use a substantial amount of their own funds. By using leverage, a smaller equity investment can control a larger asset, which can lead to higher returns when the company performs well.

Additionally, utilizing borrowed funds amplifies both the rewards and risks associated with the investment. If the acquired company generates sufficient returns, the profits made on the investment can greatly exceed the cost of the debt repayments. Conversely, if the company underperforms, the debt obligation still remains, and this could lead to significant losses for investors. Thus, leverage is a fundamental concept in LBOs that highlights the balancing act between risk and return.