Conflict of Interest in Investment Banking
February 12, 2025
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Anyone working in the investment banking industry for a few years has definitely come across the term “leveraged buyouts.” It creates huge risks, as well as investment opportunities. Over the years, many investment banks have been involved in financing several big-ticket leveraged buyouts.
In this article, we will explain in detail what a leveraged buyout is, and the role played by investment banks in enabling leveraged buyouts.
In simple words, a leveraged buyout is a company buying another company (which may be several times bigger than itself) using a lot of borrowed money. We know the meaning of the word “buyout.” The usage of the word leveraged hints at the use of other people’s money. In simple words, if a company worth $10 million is purchasing a company worth $40 million using a lot of debt, then it can be called a leveraged buyout.
Now, the question arises about how can a company worth $10 million ever raise the $40 million required to buy the bigger company! This is where the investment bankers come in. They have created a different kind of business model for leveraged buyouts in which the money lent to the buyer is secured by the assets of the target company. Therefore, once the acquisition goes through, the assets of the $40 million company will be held as collateral until the debt is repaid.
It is easy to see why many companies like leveraged buyouts. If they do well, they earn a handsome return on their investment. However, if they don’t do well, then the loss is borne by the acquired company since its assets have been used as collateral.
Investment bankers are the experts in raising capital, and a leveraged buyout involves the usage of large amounts of capital. Hence, they have a very important role to play. The details of the role have been mentioned below:
Every investment banker cannot pull off a leveraged buyout deal. It requires a certain amount of skill as well as expertise to do so. This is because most of the bonds issued as a result of leveraged buyouts are junk-rated. This means that the investors will not be easily willing to purchase them and may also ask for a higher interest rate. Seasoned investment bankers have deeply entrenched distribution networks which they leverage to sell these bonds.
To sum it up, leveraged buyouts are a specialized field in investment banking. Over the years, such transactions have turned out to be money-spinners for investment banks. However, investment bankers are required to have an excellent network to pull it off.
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