Reading Comprehension

In the early to mid-1980s, a business practice known as a "leveraged buyout" became popular as a method for companies to expand without having to spend any of their own assets. The leveraged buyout was not without its problems, however, and in time it came to represent in the public imagination not only corporate ingenuity and success, but also excess and greed. Many of the main corporate figures of the 1980s saw spectacular rises and, perhaps inevitably, spectacular falls as they abused the leveraged buyout as a means to extraordinary financial gain.

A leveraged buyout entails one company purchasing another using the assets of the purchased company as the collateral to secure the funds needed to buy that company. The leveraged buyout allows companies to take on debt that their own assets would have been insufficient to secure in order to finance expansion. The benefit of the leveraged buyout is obvious: companies with insufficient funds can still expand to compete with larger competitors. The drawbacks, however, became apparent only after the fact: the purchased company must perform extraordinarily well in order to generate the capital to pay off the loans that made the purchase possible in the first place. When the purchased company underperforms, the buyer must somehow find the money to pay off the loans. If such funds are not obtained, the buyer may be forced to sell off the company, or parts thereof, for less than the purchase price. In these cases, the buyer is still responsible for repaying the debt that is not covered by the sale price. Many of these deals resulted in the evisceration of the purchased companies, as subparts were sold to pay down the loans and employees were laid off to reduce costs and increase profits.

The most famous leveraged buyout is probably the 1988 purchase of RJR Nabisco by Kohlberg Kravis Roberts ("KKR"). The purchase price for the corporate giant RJR Nabisco was $25 billion, almost all of which was borrowed money. The takeover was "hostile," meaning that RJR Nabisco resisted any overtures from potential buyers. KKR ultimately succeeded by buying a controlling interest in RJR Nabisco, thereby obtaining voting control over the company. By the mid-1990s, though, KKR had seen a reversal of fortune and was forced to sell off RJR Nabisco in order to relieve itself of the crushing debt load.

The 1980s were the heyday of the leveraged buyout, as lending institutions were willing to loan money for these ventures. When the deals turned out to be much riskier in life than on paper, the lenders turned away from the buyouts and returned to the notion that borrowers must possess adequate collateral of their own.