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Capital Structure for U.S. Buyouts, 2014

  • Posted By: Ari Cuperfain

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  • Comments: 1

Private equity transactions are financed through a combination of equity and various forms of debt. The relative distribution of equity and debt as financing sources is variable and highly dependent on market conditions. For example, when credit markets are strong and banks and specialty debt providers are under pressure to lend money, PE firms are able to fund a large proportion of a given transaction with debt.  Put another way, accommodative credit markets require a smaller equity investment for a given business. The converse was true during the financial crisis.

In general, plentiful and inexpensive credit drives PE activity and valuations.  A smaller equity investment for a given business translates into higher expected returns on private equity investments.

During 2007, prior to the credit crisis, U.S. PE firms were able to finance their investments at a median total debt/EBITDA multiple of 5.7x. This number dropped to 4.0x during the crisis (in 2009) and remained around 4.5x through 2012. In 2014, the median debt/EBITDA multiple was 5.8x, slightly higher even than pre-crisis levels. With credit markets essentially recovered from post-crisis uncertainly, PE firms again have access to highly leveraged transactions, driving up valuations and allowing them to execute on more investment opportunities. While the data above is for U.S. buyouts, it is representative of the Canadian market as well.

Currently, only about one third of a given transaction is financed through equity (35% in 2014), with the remainder financed through various forms of debt.  For highly leveraged transactions, this typically includes a combination of senior and mezzanine debt. As mentioned previously in the discussion about Canadian Private Equity in the Global Context, PE firms have accumulated un-invested (or “overhang”) capital in excess of US$500 billion. In effect, this investible equity capital translates to almost US$1.5 trillion worth of PE transaction potential if one assumes 65% of the aggregate transaction value is financed with debt.

This confluence of accommodative credit markets and excess investible capital has created a seller’s market. Today, PE firms are able and willing to offer historically high valuations. The standard limitations on private equity fund lives – if the funds raised are not invested after a certain period of time, they must be returned to the limited partners – will continue to exert pressure on private equity funds to deploy their capital in investment opportunities.

By employing proper techniques, business owners can capitalize on the current strength in this market to realize unprecedented valuations for their businesses.

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