Leveraged Finance
Key Highlights
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Leveraged finance is when companies borrow a lot of money to fund big moves like buying another company, doing a leveraged buyout (LBO), or restructuring their finances.
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It’s common for companies with lower credit ratings and involves using debt to boost potential profits, though it comes with higher risks.
What is Leveraged Finance?
Leveraged finance is when companies borrow a lot of money to fund big moves like buying another company, doing a leveraged buyout (LBO), or restructuring their finances. It’s common for companies with lower credit ratings and involves using debt to boost potential profits, though it comes with higher risks.
Key Tools in Leveraged Finance
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Leveraged Loans (Senior Bank Debt):
These are loans that sit at the top of a company’s debt pile, often backed by assets like property or equipment. Banks or big investors provide these loans, which can include term loans or a revolving credit line (like a credit card for businesses). They’re safer than high-yield bonds. -
High-Yield Bonds (Junior Debt):
Bonds issued by companies with lower credit ratings. They pay higher interest to make up for the extra risk and are often used to fund buyouts, mergers, or debt refinancing. -
Asset-Based Loans (ABL):
Loans where a company can borrow based on the value of its assets, like inventory or unpaid invoices. These are secured by those assets, making them less risky for lenders.
Risks and Benefits
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Leverage: Borrowing money to increase potential profits. It’s like betting big—if things go well, you win more, but if they don’t, losses can be bigger too.
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Default Risk: Because leveraged finance involves a lot of debt and riskier companies, there’s a higher chance the borrower might not repay. Secured loans are safer due to collateral, but junior debt (like bonds) is riskier.
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Higher Returns: The big draw of leveraged finance is the chance for bigger profits. Equity owners can see larger gains, and debt investors get higher interest from riskier loans or bonds.