Leverage anyone?

If we buy or create a company using a significant amount of borrowed money (bonds, loans - all kinds of promises) to pay for it, we are using leverage. The assets of the company being acquired, in addition to the our assets (or not) are used as collateral for the loans.

The purpose of using this leverage is to allow us to make a large acquisition without having to commit a lot of capital. The deal will most likely require a ratio of 70% debt to 30% equity (90% to 95% isn't crazy) of the target company's total capitalization. The equity component of the purchase price will be supplied by a pool of private equity capital (investors). The investors are the ones who will decide how crazy it is.

The capital can be borrowed through a single source or a combination of sources. In most situations this type of debt will be considered high risk (not unlike some high yield junk bonds - often junkier than that, but there are limitations) . It's also likely that the debt will appear on the new company's balance sheet and the new company's cash flow will be used to repay it. The new entity must make money beyond the amounts paid to investors for the use of the money, or else this isn't going to be all that much fun. It's not for the squeamish. In light of the risk, the return is deservedly handsome. The investor can earn a decent coupon, plus a share of distributable earnings.

These arrangements can take many shapes. As far as I can tell, there is no such thing as a "standard deal". If the plan makes sense, is neatly described, well executed - there is a market for this type of idea - even on a small scale. As long as the winds (things outside of the company's direct control) blow in the right direction - there are attractive returns available. The investor can also get less than expected or worse... nothing.

With a little help from the experienced architects of such arrangements, the possibility exists.

(or not)