This article is specifically about LBOs on the buy-side of corporate finance. In a leveraged buyout (LBO), a private equity firm uses as much leverage as possible to acquire a business and maximize the internal rate of return (IRR) to equity investors. LBO buy-side entities include private equity firms, life insurance companies, hedge funds, pension funds, and unit trusts. These entities have pools of funds that they are ready to invest in profitable ventures, to generate returns either for themselves or for their clients. They rely on sell-side reports to carry out their own analysis and make recommendations.
Buy-side analysts work in non-brokerage firms, and they conduct research on potential investments and give recommendations to the company’s money managers. Unlike sell-side reports (equity research) that are made public, buy-side recommendations are kept confidential. The aim of buy-side firms is to identify and purchase underpriced assets, and to earn high returns on their investments.
In a situation where the buy-side analyst conducts market research and identifies a high performing company that is being sold, he isolates that information so that other investors do not influence a price hike. If he is convinced that the business is profitable and the stock is competitive, he makes a buy recommendation to the firm or to high-powered clients. If both parties agree that the company is worth investing, then they go ahead in financing the purchase, with a mix of both equity and leveraged debt to ensure higher returns on investment.
The buy-side analyst’s success is measured based on the number of profitable recommendations that he makes, with the aim being to buy low and sell high. They earn commissions and bonuses on every successful investment.
Buy-Side LBO Models
Below is an example of a financial model used in an LBO transaction. There are many types of financial models, and LBOs are just one of them.
In a leveraged buyout, there is a sell-side and a buy-side. The sell-side entities comprise brokerage firms such as investment banks, stockbrokers, and market makers. They keep track of stocks and the performance of various companies, which they analyze, and generate research reports. The reports are usually made available to the public. The LBO buy-side entities take up these reports to do their own analysis and make recommendations to their seniors. Buy-side entities take speculative positions and aim to gain from market movements and accruals.
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