Elon Musk bought Twitter mostly with other people's money (or OMP, as the cool finance kids say). Weird, considering at that time, he was the richest person in the world, no?
Well, it turns out that rich people love buying stuff with OMP, so much so that there's a name for it: the leveraged buyout.
A leveraged buyout is when an investment firm borrows money from banks to acquire "stable" and "mature" companies. But the debt is added onto the balance sheet of the company being bought, not the firm doing the buying.
- The buyer then looks for ways to make the new purchase more profitable and uses those profits to pay off the debt, resulting in a money-making and, eventually, debt-free asset.
But there's a reason some have labelled them “predatory” in the past:
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Bankruptcy risks increase. A targeted company might find itself overwhelmed with the new debt and unable to meet its financial obligations.
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Financial instability. Being overleveraged means any dramatic changes in the market can be hard to weather.
- Job losses and downsizing. Cost-cutting measures tend to be top of mind for the buyer—cutting staff is a quick and easy way to boost profits.
And leveraged buyouts can have economic consequences that reach far beyond just the companies involved in the deal.
- As we've seen with Twitter, a change in ownership can change (for better or worse) how a product or service operates.
- Leveraged buyouts can also influence a publicly traded company's share price, affecting shareholders.
Just because you aren't one of the hands shaking and making deals doesn't mean leveraged buyouts don't involve you. Understanding how they work, why they happen, and their potential consequences can help you make better investment decisions.