What is a function of using leverage in a leveraged buyout acquisition?

Using leverage in a leveraged buyout (LBO) acquisition enhances potential returns on investment by allowing the acquiring firm to use borrowed funds to finance a significant portion of the purchase price. When an investor utilizes leverage, they can acquire a larger asset or company than they would be able to with only their own capital.

The core idea is that the equity investment — the capital contributed by the investors — remains relatively small compared to the overall size of the investment. As the company generates cash flows, these can be used to pay down debt, and any appreciation in the value of the company predominantly benefits the equity holders. Consequently, if the investment performs well, the returns on the equity invested can be magnified because the returns accrue on a larger base of assets, while the capital invested by the equity investors remains modest.

This principle of leveraging amplifies the upside potential of the investment. If the acquired company increases in value, the returns on the equity investment are substantially higher due to the relatively small equity base compared to the total values involved in the transaction.