Middle Market Leveraged Buyout De-Risking

Posted on: July 5th, 2021

leveraged buyout

Leveraged buyouts by their very name sound a bit ominous. Large amounts of debt are central to this transaction structure, their single most identifying feature. All middle market leveraged buyouts are usually well conceived strategically and contain a high level of equity to undergird the debt structure. Financial engineering issues usually play a large role in the financing process for all leveraged buyouts, as they are not easy deals to finance.

Best Candidates for Leveraged Buyout

As the middle market has grown due to inflows into private debt, it seems leveraged buyouts of all shapes and sizes are afoot. Sponsors of leveraged buyout get extremely focused on the financing approach sometimes at the expense of deal selection and screening. In truth, not all businesses are good candidates for leveraged buyout. And for a business to manage in a leveraged environment, it needs to be extremely well managed to begin with. Leveraged buyout de-risking starts with an understanding of what makes a company a good prospect.

Stable cash flow – businesses that have steady revenue that are less sensitive to economic cyclicality.
Basic product – companies with traditional products, not subject to fast change.
Repeat revenue – companies that serve an important, everyday need and have locked in distribution.
Good Margins – companies with gross margins over 30% usually have more staying power and customer reliance.

Often sponsors overlook these basic points and assume any deal that can be a leveraged buyout. Just because a lender will give you funding, does not mean a company is a good leveraged buyout play. In addition, leveraged buyout de-risking also requires superior management talent and information systems. Operating a leveraged companies requires a level of financial planning and analysis that most middle market companies lack. The team must understand their revenue drivers and cost structure and ensure they are focused on the right day to day operating metrics. While financial engineering is important, the ultimate level of de-risking occurs in the decision to pursue the deal and having the right team at the helm.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.