Quora Answer: Why are Leveraged Buyouts Legal?

The following is my answer to a Quora question: “Why are leveraged buyouts legal?”

Before addressing why they are legal, you have to understand what they are.  A leveraged buyout is a financial transaction in which a company is purchased through a combination of equity and debt.  The company’s own cash flow becomes the collateral for that debt.  The buyer is borrowing against the company to pay for it.

Mechanics

A private equity firm identifies a target company with stable, predictable cash flow.  It contributes a small equity slice, often 20 to 30 per cent of the purchase price, and borrows the rest, secured against the target’s own assets and future earnings.  Once the deal closes, that debt sits on the acquired company’s balance sheet, not the buyer’s.  The target must now generate enough cash to service interest payments on debt it did not choose to take on, while the private equity firm works to improve operations, cut costs, or reposition the business for a profitable exit through a resale or public listing.  Mostly, they strip the company of assets, prioritising their own shareholders instead of the company’s interest.

On the surface, this is not inherently strange.  Buying a car or a house works the same way.  You borrow against the asset itself to acquire it.  A company has no fixed intrinsic value, so lenders borrow against its projected cash flow instead.  Debt costs less than equity against the capital used, reducing acquisition cost, and interest payments offset corporate tax liability, unlike dividends paid from equity, which remain taxable as income.  Few buyers hold enough liquidity for an outright purchase, and debt-financed acquisitions increase economic activity, contributing to GDP.

Hilton: The Example That Worked

Blackstone acquired Hilton Worldwide in 2007 for US$26 billion, one of the largest leveraged buyouts in history, timed immediately before the global financial crisis devastated the hotel industry.  Rather than collapse under that timing, Blackstone restructured Hilton’s operations, streamlined its portfolio, invested in renovations, and expanded the brand internationally.  Blackstone took Hilton public again in 2013, generating what is widely regarded as one of the most profitable private equity deals ever completed.  The debt load did not sink the company, because Blackstone matched the capital structure to a business capable of servicing it, even through a recession.

Toys R Us: The Example That Did Not

KKR, Bain Capital, and Vornado Realty Trust acquired Toys R Us in 2005 for US$6.6 billion, financed with over US$5 billion in debt against US$1.3 billion in sponsor equity.  The company faced interest payments of approximately US$400 million a year, an obligation that consumed the cash the business needed to compete against Amazon and Walmart.  Toys R Us filed for bankruptcy in September 2017 and liquidated in 2018, costing 33,000 jobs and wiping out the sponsors’ entire equity stake.  The brand, the customer loyalty, and the retail footprint remained strong.  The debt load made survival mathematically impossible regardless.

Legal Does Not Always Mean Ethical

There are instances where a buyout fails because the acquired company was overleveraged, and its earnings could not fund debt payments.  This traces to overly optimistic earnings projections, an overvalued asset, or too high a debt ratio.  This is bad analysis.  It does not make most leveraged buyouts illegal.

It does raise an ethical question that the legality of the transaction never addresses.  A private equity firm risks a fraction of the purchase price in equity while the target company absorbs the entire debt burden.  If the deal succeeds, the sponsor captures the majority of the upside.  If it fails, employees lose jobs, pensions face risk, and creditors absorb losses, while the sponsor’s own exposure was capped from the outset by design.  Toys R Us employees received no severance when the company liquidated, despite KKR and Bain each managing tens of billions in assets at the time.  A structure that concentrates gains with the buyer and losses with the workforce is legal.  Calling it fair requires a reworking of ethics.

The Singapore Legal Position

Singapore regulates this mechanism through Section 76 of the Companies Act 1967.  Section 76 prohibits a public company, or a subsidiary of a public company, from giving financial assistance for the acquisition of its own shares.  A public company can still proceed through the statutory whitewash procedure.  Directors must pass a board resolution declaring, in their own stated opinion, that the company can pay its debts in full as they fall due.  Every director voting in favour must sign a statutory solvency declaration personally.  Members must approve the assistance by a 75 per cent special resolution, with the acquirer and any connected parties excluded from that vote.  Creditors must receive notice, and the resolution must be filed with the Accounting and Corporate Regulatory Authority.  A simplified “no material prejudice” exception exists under Section 76(9BA), available where the assistance does not materially harm the company, its shareholders, or its ability to pay creditors.

Since 1^st July 2015, this entire prohibition no longer applies to private companies that are not subsidiaries of a public company.  A private company leveraged buyout in Singapore today faces no financial assistance restriction at all, aligning Singapore with jurisdictions such as England.

This Contrasts Sharply with the US System

The US is the home of predatory capitalism.  The US has no federal equivalent to Section 76.  No statute requires a target company’s directors to certify solvency in advance, obtain a supermajority shareholder vote excluding the buyer, or notify creditors before a leveraged buyout closes.  The primary post-transaction check in the United States is fraudulent transfer law, allowing creditors to sue after the fact if a deal was structured to hinder, delay, or defraud them, or left the company insolvent at the time of the transaction.  This is a reactive remedy, pursued through litigation once the damage has already occurred, rather than a proactive gate a Singapore public company transaction must clear before the deal can close at all.

Had Toys R Us been a Singapore public company, its own directors would have been required to sign a personal, statutory declaration that the company could pay its debts in full as they fell due, precisely the claim that proved false within twelve years.  That declaration alone would not have guaranteed a different outcome.  It would have forced the solvency judgement this deal ultimately failed on to be made, and personally attested to, before the debt was ever loaded onto the balance sheet, rather than left for a bankruptcy court to establish more than a decade later.

The Toys R Us pattern has repeated at scale in the American market this framework was built without a comparable safeguard for.  PitchBook counted 33,575 unsold private equity portfolio companies by June 2026, many still carrying debt loaded on at acquisition with no clear exit in sight.  Cerberus Capital Management’s 2010 acquisition of six Massachusetts hospitals, later renamed Steward Health Care, followed the identical playbook: minimal cash down, debt loaded onto the target, a 2016 sale-leaseback adding US$6.6 billion in rent obligations to hospitals that no longer owned their own buildings.  Cerberus exited in 2020, having tripled its investment.  Steward Health Care filed for bankruptcy in May 2024, owing over US$9 billion, including US$290 million in unpaid staff wages, and five hospitals have since closed permanently.

TXU, renamed Energy Future Holdings after its own US$45 billion leveraged buyout in 2007, the largest in history at the time, filed for Chapter 11 in 2014, wiping out US$8 billion in sponsor equity when natural gas prices collapsed against the debt assumptions the deal was built on.

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Terence Nunis | Executive Chairman, Equinox Zenith | Author, The 1% Playbook: The Billionaire Cheat Code