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Private Equity Deal-Making 101 - Evaluation, Structuring, and Restructuring
Private Equity Deal-Making 101 - Evaluation, Structuring, and Restructuring
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Private equity-backed buyouts, which dried up earlier this year as a result of the pandemic are witnessing a resurgence. The Most Popular
US institutional loan issuance tied to the Leveraged Buyout (LBO) deals rebounded to USD 9.5 billion in October, the
second-highest monthly of 2020. It is time for those in the occupation to clear their trained eyes for spotting and
engineering leveraged deals.
LBOs are the most mythical and heavily talked about deals of the financial town. Their eye-popping prices and hot
leverages require intrepid private equity managers to lead these transactions. As exciting and huge their gains (as well as
losses) are, as complex they appear to the uninitiated. Looking Beyond – Private Equity Post The Pandemic
In this article, we take a detailed look at the general principles involved in leveraged buyouts and the structuring process –
one of the coveted skills – of these attractive transactions.
money to buy undermanaged companies. Thus, they lean on banks (and other providers) for financial support, who in turn,
expect the company to make enough sum to pay back the financiers and profit shareholders.Since a significant portion of
these deals is realized through (banks’ and other providers’) debt, they are called Leveraged Buyouts (LBOs).
In a nutshell, LBOs provide an alternative for stressed companies to restructure their ownership and control and stay afloat
by using investible cash facilitated by PE funds to finance the target company.
The first goal, therefore, of an LBO deal structuring is to determine the value of the company – in relation to the debt
required for the transaction. The worth is understood from:
Equity Value: It is the value of a business after deducting debt and other claims. It can be measured through the P/E
ratio.
Enterprise Value: It reflects the company value irrespective of how it is financed. It is measured by EBIT, EBITDA, and
other methods. It can be called the operating value of a business.
Net Book Value of Assets: It represents the company’s value in the books minus intangibles such as goodwill, patents,
and debt liabilities.
Valuation goes hand in hand with financial engineering strategies, which derive a company’s potential value in periods
following the acquisition and project a rate of return with different strategic combinations. A few capital structuring The New Private Equity: Creating Value Through
Reducing weighted average cost of capital by taking larger debt, leading to a high yield to equity ratio.
Lowering capital costs by refiguring company’s assets through, say sale (or licensing) of intellectual property,
implementing stringent work capital plans, sale of real properties or assets.
Combining stressed company’s assets with other businesses to expand its scale and incur higher value for a combined
company. It is also called a roll-up strategy, often employed in the retail sector.
SENIOR DEBT
Senior debt has the topmost priority among all debts with respect to receiving interest or proceeds in case of insolvency. It
is usually a loan from the bank. It has several safeguards for the lender, and thus offers a lower rate of return.
Risk: Low
Features
It offers a risk and reward profile that is above senior debt but below equity. It can be provided by special mezzanine funds
or banks.
Risk: Medium
Features
Equity holders get the highest rate of returns owing to the high risks taken by them. Therefore, PE managers are the
bulwarks who look closely at the working capital of a business and structure an optimal deal – via financial engineering
and negotiations with other lenders.
Risk: High
Features
These are the three interlinked, but individual reasons due to which the financing structure designed at the time of initial
transaction can fall apart:
When cash flow from daily operations becomes negative. It implies loss-making, and that the business is spending more
than it earns.
When positive cash flow is insufficient to fulfill funding requirements of the business. It occurs when one borrows more
than it can repay.
When the debts fall due, and non-compliance makes it insolvent.
If the lender is convinced that the distress can be alleviated by rescheduling the debt repayments, then restructuring can be
done by amending the existing debt covenants. Under this, the term of the loan can be increased. Since, this structure
represents higher risks than earlier, a part of the loan is repackaged and repriced as a mezzanine.
Infusing new equity isn’t so simple. It is unlikely that PE funds or lenders will undertake this option to reduce debt
obligations of the business. However, if there are credible reasons that justify the move to inject new equity, it can be done
by the banks. It enables quick restructuring.
Banks receive the lowest return in PE LBO deal structures because they take the lowest risks. If it is perceived by them that
their risks have become similar to that of PE investors and managers, it is not uncommon for the banks to reprice the
debt, and convert their debt portion into equity holdings (thereby reducing equity holdings of other shareholders).
Albeit a traditional practice, it is still used. If a company accumulates too much debt, then equity investors can negotiate
with the banks and convince them to write off a part of the debt under overall restructuring plan. New equity may be
injected as a result.
Whether private equity professionals will engage in structuring and restructuring is contingent on whether they can bolster
the value of the businesses they invest in. Any structuring or restructuring requires a blend of sharp financial acumen and
strong negotiation. Chartered Private Equity Professionals (CPEP™) bring to the table the skills and exposure to
deal with complex financial states.
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