Why is having a large amount of tangible assets essential in an LBO?

Having a large amount of tangible assets is essential in a leveraged buyout (LBO) primarily because it allows for lower-interest financing and more manageable debt repayment. When a company has significant tangible assets, such as property, equipment, or inventory, lenders view these assets as collateral. This tangible backing reduces the lender’s risk, making them more comfortable extending credit at lower interest rates. The presence of these assets enhances the ability of the company to secure favorable borrowing terms.

Moreover, in an LBO context, substantial tangible assets can bolster the company's cash flows. These tangible assets can often be liquidated or used as leverage in negotiations with financial institutions. This capability is vital in the context of debt repayment; having solid, tangible collateral means that lenders may extend larger sums than they would to a company with fewer or less secure assets, thus facilitating higher levels of debt financing. Proper management of such debt becomes critical to ensuring that the LBO can generate sufficient returns for equity holders while meeting its obligations to creditors.