What characterizes a leveraged buyout (LBO)?

A leveraged buyout (LBO) is characterized by the use of a significant portion of borrowed funds to finance the acquisition of a company. In an LBO, the acquiring party typically uses debt to cover a majority of the purchase price, with the expectation that the acquired company's cash flows will be sufficient to service that debt. The utilization of leverage amplifies the potential return on equity for the investors, as they are using a smaller portion of their own capital relative to the total investment.

This structuring allows buyers to amplify their purchasing power and potentially achieve higher returns, albeit with increased risk due to the reliance on debt financing. If the acquired company performs well, the returns on equity will be maximized, but if it does not, the burden of the debt can lead to financial distress.

In contrast, other options describe different financial mechanisms. Funding an acquisition primarily by equity does not fit the definition of an LBO since it lacks the leverage aspect. A takeover where payment is made in stock pertains to a different strategy involving stock exchange rather than borrowing. Lastly, purchasing a company funded through cash reserves does not involve leveraging, thus removing the key characteristic that defines a leveraged buyout.