A leveraged buyout is the acquisition of a company by using a large amount of borrowed money generally from banks and a smaller amount of equity to meet the cost of acquisition. Generally assets of the target company are used as collateral for the loans, along with the assets of the acquiring company. Debt and equity percentage used for the acquisition is generally 90% percent for the former and 10% for the latter. It is considered a unique way of acquisition as the target’s company’s assets and shares are used as collateral. Leveraged buyouts first emerged in USA as a phenomenon. Since then, it is actively used around the world especially by the private equity firms. However, with the failure of the some of the most popular leveraged buyouts due to the default of the company as a result of the unpayable debt, this method of acquisition financing has lost its former popularity.

Leveraged Buyouts and Research and Development

Corporate restructuring following a merger, acquisition or a leveraged buyout affects the company as a whole and naturally affects the managerial decisions of the company. The new management may opt to increase research and development expenditures or to decrease it. Managerial decisions post-transaction will have a profound influence regarding the future of the company when it comes to research and development. The degree of impact of the abovementioned transaction would also depend on the type of the transaction.

As previously mentioned, leveraged buyouts are conducted through debt financing and equity financing is often low compared to the debt. As a result of such transaction debt-equity ratio of the company increases and that would put pressure on the firm to use its cash flow to offset the increases in debt-equity ratios which generally put pressure on the firm to use its cash flow to service the long term debt at the expense of investments, particularly those of a long term nature such as research and development activities.[1] Another problem would be the commercialization of the intellectual property created as a result of the research and development activities conducted by the acquired company. Since the commercialization of the developed intellectual property is most of the time risky and may not yield intended results. In addition, commercialization, depending on the product cycle, may take years. For the reasons stated above management of the acquired company would more likely to engage in activities that are short-term and pay-off the debt owed.

In addition to problems mentioned above, leveraged buyouts may also reduce the expenditures for market research which is often vital to research and development activities.[2] Market research is a major source of ideas and data for applied and developmental research and development activities. It is also important for the commercialization of the intellectual property. Fewer market research efforts may affect research and development activities in a way that it may alienate acquired companies from market trends. Leveraged buyouts may also lower the staff allocated to research and development activities and by lowering the research and development expenditures, It can deprive companies of the talent necessary for conducting activities that lead to innovation.

Leveraged buyouts may also yield positive results for research and development activities. The new management may opt to increase the research and development expenditures as previously mentioned or executives may focus on long term goals compared to short term goals depending on the debt-equity ratio of the company. Furthermore, after a leveraged buyout management may decide to narrow the business concepts and dedicate to one major industry (for example a car manufacturer may stop manufacturing hybrids and just manufacture electric cars). Thus, the research and development may be redirected to the redirected industry. Innovation oriented managers would more likely to increase the research and development activities.

Following a leveraged buyout, managers should carefully evaluate the aspects of the research and development activities. The managers would likely to base their decisions on the financial situation of the acquired company and ensure that company does not go bankrupt. However a prospective intellectual property and successful commercialization of such property may significantly improve the financial conditions of the acquired company.