Four Fundamentals for Financing Leveraged Buyouts

Posted on: June 23rd, 2021

leveraged buyouts

Leveraged buyouts are a powerful means of achieving transformative value for a sponsor. Using debt to fund much of the purchase price allows a buyer to leverage their equity investment and amplify their returns. Deal structures with equity contributions of 20% of value, allow the purchaser to acquire an asset of 5 times the equity investment.

Growth of Leveraged Buyouts

The leveraged buyout market has grown significantly over the past 50 years with the emergence of professional private equity platforms focused on large, multi-billion deals as well smaller middle market deals. The private debt markets have increased in sophistication and efficiency with the advent of public debt platforms and the proliferation of direct lending funds. Valuations tend to generally align according to company size and sector appeal, with larger companies commanding higher prices and high margin, high growth companies commanding premium pricing.

Regardless of where your leverage buyout deal falls in the valuation spectrum, there is a shortlist of key fundamentals that the company needs to be a good leveraged buyouts candidate. The fundamentals often get muted in a buyout frenzy environment where financing availability is frothy. These fundamentals are important for leverage buyout entrepreneurs to know as they embark on their buyout journeys. Centering your deal on these fundamentals will allow you to raise acquisition financing more easily and close in a timely fashion.

Here are the Attract Capital 4 Fundamentals for Financing Leveraged Buyouts.

Favor low capital-intensive businesses – businesses with high capex such as equipment or research & development charges, require more capital over time than low intensity businesses. This diminishes the level of free cash flow available to service debt and creates more fixed charge requirement.
Favor companies with pricing power- Companies with low (<10%) EBITDA margins are usually in competitive industries with commodity price pressure. Strong performing companies usually have pricing power with EBITDA > 10% and gross margins greater than 30%. Pricing power is important to ensure sustainable profit for long term debt service.
Favor wide customer base and low concentration- acquisition financing lenders screen aggressively for customer concentration, and usually avoid lending to companies that have more than 20% of revenue tied up in one customer. Despite long term customer relationships and high levels of customer reliance, the loss of this relationship can kill a business.
Favor spread of risk, predictable revenue companies– companies that sell one-time projects or large ticket sales tend to have more lumpy revenue profiles. Lenders prefer to have a more predictable revenue profile consisting of a large volume of smaller ticket sales.

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.