Posted on: June 9th, 2022
With leveraged buyouts, the raging question is always how much equity do I need to put in? It is a fair question for independent sponsors, who are not backed by large funds and often invest their own capital or raise capital from a select few. The question takes on more importance as the available pools of private debt capital available for leveraged buyouts grow. The question historically was focused on either a bank funded leveraged buyout deal or a mezzanine debt funded transaction.
Nowadays, there are other purveyors of leveraged buyout capital, who have their own criteria to satisfy. The answer to this question is that universally non-committal response, it depends on a number of factors. It is impossible to generalize and provide a one-size fits all answer, though there are some industry guidelines that can help. The answer starts with the price, and how well you are buying the asset. Are you paying a low EBITDA to price multiple, for example 3 to 4 times or are you paying 10 times? The answer proceeds to deal size and industry type. Larger deals, EBITDA >$10 million, historically receive much higher multiples than smaller deals, EBITDA < $2 million.
Also, each industry has its own prevailing multiple valuation metrics. Tech companies in the SaaS field receive very high multiples (12x+) where small retail business usually score low multiples (sub 3 times). The inherent stability of the business and the reliability of its future cash flow plays a big role as well. If the business is seen a steady business, then the bank or debt fund will be more comfortable with a lower equity percentage. The leveraged buyout lender’s strategy also plays a big role in determining the equity amount. Some lenders look at the deal on a loan to value basis and compare independent equity deals to private equity backed deals. Even if the purchase multiple is lower and the asset quality is high, their comfort may only be at lending 55% LTV.
Finally, the existence of other non-cash equity also matters including seller rollover equity, seller notes and other forms of deferred consideration. Depending on how these backends are structured, your leveraged buyout lender will frequently give you credit for this as buyer equity. The rule of thumb for independent sponsors is to ensure you have 25% to 30% total equity in the form of cash equity, seller note and rollover equity for a reasonably priced deal. The sum of these three need to be at least 25% with the cash equity comprising at least 15%. Most importantly, the cash equity needs to be seen as meaningful in the eyes of the lender. Without a meaningful level of buyer equity commitment, there is no incentive for the leveraged buyout lender to consider the deal.