Posted on: August 26th, 2021
Middle market leveraged buyout range widely in size from $10 million to $500 million+. The size of the middle market private debt segment has grown significantly over the past 30 years with more funds and larger fund sizes. Back in the early 1990’s a large fund was $250 million.
Today, a large fund is $2 billion+ in size. Larger fund sizes have driven the trend toward increased deal size. This has naturally increased the upper end of the deal size range. Regardless of the deal size, leveraged buyout lenders filter deals according to credit metrics such as leverage multiple, loan to value ratio and debt service coverage ratio. These credit metrics are the intelligence prism of leveraged buyout lenders, enabling them to assess risk-return and credit risk, quickly and accurately.
Many independent sponsors have general awareness of these credit metrics but can be lax in applying them to their deal on the front end to assess finance ability. Given the enormous investment required to close a leveraged buyout, it is highly advisable to think like a lender on the front end and make sure your deal conforms to their standard credit metrics. The leverage multiple is calculated by dividing total debt by the historical EBITDA. The total debt is the pro forma amount at closing and EBITDA is usually the trailing twelve month adjusted EBITDA.
Smaller Leveraged Buyout Deals
For smaller deals, lenders use a range of 3 to 4 times EBITDA. For larger deals, the range is 4.0 to 5.5 times EBITDA. Loan to value ratios is used frequently in private equity backed buyouts but are also used in independently sponsored deals. The ratio is calculated by using the total debt as the numerator and the total enterprise value of the deal as the denominator. Leveraged buyout lenders use a range of 55% to 65% for fully priced, larger private equity deals. This ratio skews higher (60% to 75%) for lower priced deals including independently sponsored deals, where purchase multiples are lower. Within the equity component of this structure, lenders will give you credit for properly structured alternative equity such as seller notes and rollover equity.
Finally, debt service coverage is an indispensable criterion that measures the company’s ability to service its debt. This ratio is calculated by using the EBITDA less Capex and other mandatory operating expenses as the numerator and total debt service including interest and principal payments as the denominator. Most lenders require a debt service coverage ranging from 1.10 to 1.35, depending on the credit strength of the company and their seniority in the debt stack.