Leverage makes it possible to increase shareholders’ capital gains by financing acquisitions with capped-rate bank loans. This debt is generally in the holding vehicle and is repaid with cash generated by the operating company (usually distributed in the form of dividends).

Leverage only works if:

1. the company generates recurrent cash flows

2. the interest rate on the bank loan is lower than the overall profitability of the LBO

Example:

• Acquisition of a company for €30m
• Financed with €15m of capital and €15m of debt (senior or mezzanine), APR of 6% paid annually
• Sale of the company for €75m after three years
• Total multiple = 2.5x of the initial value
• Interest on debt = 6% per annum, i.e. a total of €17.7m and a multiple of 1.2x
• Value of equity = €57.3m, i.e. a multiple of 3.8x