Leveraged Buyouts, EV/EBITDA, and Private Equity Insights

Posted on Feb 9, 2025 in Economy

Leveraged Buyouts: An Overview

Leveraged Buyout (LBO): A financial transaction where a company is acquired using a significant amount of borrowed funds to cover the acquisition cost.

Key Drivers of LBOs

  1. Target company valuation (attractiveness and valuation)
  2. Debt Financing (terms of debt financing)
  3. Equity investment
  4. Market and economic conditions
  5. Due Diligence (legal, financial impact)
  6. Management team
  7. Exit Strategy

Success Factors

The success or failure of a deal impacts ROI, but several factors contribute to success:

  1. Financial returns
  2. Well-planned Exit Strategy
  3. Operational Improvements (implementing enhancements and initiatives)
  4. Value Creation

Failure Factors

  1. Poor financial performance
  2. Unsuccessful exit
  3. High levels of debt
  4. Market downturn
  5. Ineffective management

EV/EBITDA: Understanding the Metric

EV/EBITDA: Enterprise value to earnings before interest, taxes, depreciation, and amortization.

Strengths of EV/EBITDA

  1. Simplicity
  2. Normalizes Capital structure (provides a measure of a company’s total value, irrespective of its capital structure)
  3. Useful comparison
  4. Cash flow focus (measures a company’s ability to generate cash)

Weaknesses of EV/EBITDA

  1. Not adjusted for Capital expenditure (No Capex)
  2. Dependence on earnings
  3. Industry sensitivity (different industries may have varying levels of capital intensity and working capital requirements)
  4. Ignores taxes (Unleveraged basis)
  5. Leverage Sensitivity

Issues with EV/EBITDA

  1. Overemphasis on earnings
  2. Not a standalone metric
  3. Market fluctuations
  4. Doesn’t capture worth

Private Equity Industry: Positives and Negatives

Positives of Private Equity

  1. Capital injections and investment (helping grow, expand, or restructure companies in need)
  2. Operational Improvements (expertise and managerial resources to portfolio companies and strategic initiatives)
  3. Job creation and economic impact
  4. Restructuring and turnarounds
  5. Portfolio diversification for investors

Negatives of Private Equity

  1. Short-term focus and exit pressure (potentially sacrificing long-term sustainability for short-term gains)
  2. High levels of debt
  3. Job losses and cost cutting (leading to layoffs and workforce reductions)
  4. No transparency

Carried Interest (Carry)

CARRY: Refers to “carried interest”, which is a share of the profit that General Partners (GPs) in a Private Equity fund receive as part of their compensation.

How Carried Interest Works

  1. Profit participation (Carried interest allows GPs to share in the profits generated by the fund (% of the funds))
  2. Hurdle rate (Minimum rate of return to GPs entitled to any carried interest)
  3. Carry percentage (15%-30% outlined by LPA)
  4. Distribution waterfall

Restructuring Deals

Restructuring deals work: When a portfolio is facing financial distress, operational issues, or lacks viability. The goal is to stabilize the business, enhance its value, and position it for Long Term success.

  1. Identifying financial distress (declining revenues, liquidity issues)
  2. Assessing the situation (review the capital structure, debt obligations)
  3. Negotiations with creditors (Extending maturity dates, reducing interest dates)
  4. Operational Improvements
  5. Debt-to-equity swaps
  6. Liquidity management (injecting additional capital to stabilize)
  7. Stakeholder communication between employees, customers