Healthy Debt Multiples for a Leveraged Buyout

Posted on: June 17th, 2022

leveraged-buyout

Middle market debt multiples are important structuring yardsticks when planning your leveraged buyout. Leveraged buyouts are a form of a corporate finance transaction wherein loans are used to fund the acquisition of ownership of a company. The purchase price is paid through leveraging the deal by structuring a loan against the cash flow value of the enterprise. The purchase price can also be paid through loans against the hard assets of the company, but most true leveraged buyouts are consummated at price levels far beyond mere asset value. When buying a company, the tendency is to stretch the debt capacity to allow you to control the deal with a smaller equity investment, thereby increasing returns.

Risks of Leveraged Buyout

However, given the inherent risk in a leveraged buyout, it is smart not to push the debt multiple too far, lest the company become overleveraged and unmanageable. Leveraged buyout debt multiples range from a low of 2.5 times for smaller middle market deals to 4.5 for larger, more mature deals. Debt multiples should be all encompassing as to all forms of debt needed for the initial acquisition and for future growth. Often, buyers get carried away with a deal and decide to leverage their current assets to finance part of the purchase price, as opposed to preserving that collateral for a line of credit. This restricts a company’s liquidity and makes it far more difficult to make investments and course correct, if needed.

A healthy leveraged buyout debt multiple should reflect the following factors:

Excess Financing Availability – all recently acquired companies need additional investment in the form of growth capital or working capital to unlock their growth potential. The Company should reserve at least a half a turn of EBITDA in dry powder.
EBITDA sustainability – weak EBITDA can lead to a very high EBITDA multiple. Lower Debt multiples should be used in the case where EBITDA is hard to project or volatile.
Pro forma Adjustment reality – debt multiples built on adjusted EBITDA need to ensure that adjustments convert to real profits. As the Company pulls out of the trailing twelve-month adjustment period, it replaces adjusted pro forma results with unadjusted actual results. If this conversion does not occur, you will bust your debt multiple covenants.
Public Valuation Noise – some large public companies have stratospheric valuation and large debt multiples, often in excess of 8 to 10 times. Just because these stock market darlings have these high multiples does not mean your middle market deal should. Middle market deals should hew to conservative multiples due to their higher risk and their lack of easy access to the public capital markets.

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.