Private Equity and Leveraged Buyouts

Leveraged Buyout

• A leveraged buyout is the acquisition (purchase) of a

business, financed mostly with debt (borrowed money), made by an

equity sponsor (like an investment firm)

• The acquired business can be an entire company

or a piece of a company

• After the acquisition is completed, the company’s

common stock is usually no longer publicly traded

• LBO’s (Leveraged Buyout) are typically financed with 60-75% debt (borrowed) and

25-40% equity (what buyer puts down)

– The debt in the capital structure usually consists of

multiple levels of varying seniority (some lenders get paid back first)

Equity Sponsors

Equity Sponsors

• Most of the equity (equity is ownership value—it’s how much of something is actually yours after you clear out what you owe on it) in leveraged buyouts is provided by investment firms which specialize in these types of transactions. They go by many names, including:

– Equity sponsors

– Private equity firms

– Financial sponsors

– LBO firms

• Equity sponsors obtain their funding from a variety of sources, including wealthy individuals, pension funds, and financial institutions

Equity

equity is ownership value—it’s how much of something is actually yours after you clear out what you owe on it.

Imagine you buy a $20,000 car. You put down $5,000 of your own money and borrow $15,000 from a bank.

• Asset (What it’s worth): $20,000

• Debt (What you owe): $15,000

• Equity (What’s actually yours): $5,000

If you sold the car today for $20,000, paid off the bank's $15,000, you'd walk away with $5,000. That $5,000 is your equity.

Equity Sponsors do what?

• Equity Sponsors raise money for a fund, which

then invests equity in a number of leveraged

buyouts

• Equity sponsors generally seek returns on

equity of 20% or greater on their investments

• Equity sponsors typically like to cash out of

their equity investments in leveraged buyouts

in 5 years or less

Large and known Equity Sponsors

– Blackstone

– Apollo

– Texas Pacific Group

– Carlyle

– KKR (Kohlberg Kravis Roberts)

– Bain Capital

– Silver Lake

– 3G Capital

Capital Structure of a Typical LBO

• A leverage buyout’s capital structure usually has multiple layers of debt and equity financing

• A typical structure would have the following layers:

– Senior Secured Loans

– Senior Unsecured Bonds

– Subordinated Bonds

– Common Equity

Senior Secured Debt

• Typically consists of loans borrowed from banks, CLOs, mutual funds, and hedge funds

• Usually consists of a revolving credit facility and a term loan

– The revolver usually has significant unused borrowing capacity at closing to provide flexibility for the company

– The term loan usually has a 5-7 year maturity, with a LIBOR-based floating interest rate

• Senior secured debt typically has the most and strictest covenants in the capital structure

• It is paid down with excess free cash flow

• Sometimes 2nd-lien secured debt is also used

– 2nd-lien debt is secured, but junior in priority to 1st-lien debt

Hedge Fund

Hedge funds are actively managed funds focused on alternative investments that commonly use risky investment strategies.

• Investing in a hedge fund is generally open to accredited investors with a high minimum investment or net worth.

• Hedge funds charge higher fees than conventional investment funds.

• Hedge fund strategies depend on the fund manager and relate to equity, fixed-income, and event-driven investment goals.

• A hedge fund investment is usually locked up for a year before shares can be sold

Collateralized Loan Obligations (CLO)

CLOs are a segment of securitized fixed income markets which offer investors varying levels of income and risk, depending on the securities they choose.

• Today, more investors are allocating to CLOs as their floating rate coupons can offer potential protection from interest rate volatility, as well as higher yields compared to similarly rated corporate debt.

• Due to CLOs’ unique characteristics, an experienced portfolio management team may be beneficial to leverage when choosing to invest in this asset class.

• ETFs can offer an efficient way to access CLOs, whether it be through a multi-sector strategy or through CLO-focused ETFs.

LIBOR

Benchmark interest rate at which major global banks lent money to one another on a short-term basis in the international interbank market.

Covenant

A covenant is a formal agreement within financial contracts that outlines the conditions or restrictions agreed upon by the parties involved to safeguard mutual interests. Meant to protect the parties involved.