Entrep Finance & Private Equity 6

• levering up;
• multiple arbitrage – buying at a low multiple and selling at a high;
• adding value to the operations of the company

The guest speaker, of the mid-market firm here in Chicago provided also some valuable insights. One of the key developments of the buyout market during the 90’s was the increase in the equity contributions from as low as 10% in the 80’s to about 30-35% currently. The same thing happened to purchase price / EBITDA multiple and to debt / EBITDA multiples.

Buyout market is said to become more efficient. One of the difficulties that the mid-market buyout firms are facing is that the ability of the firms to do IPOs goes down – you have to be increasingly bigger, in part due to Sarbanes-Oxley. Scott later added that low to mid-market buyouts were not a business due to the fact that in order to do an IPO the pre-money valuation has to be at least $100 million (because in an IPO you cant sell more than a third of a company and the amount raised needs to be no less than $50 million). So all the low- to midmarket firms were at the whim of strategic buyer. That isnt the case now, but I missed why…

“Everything in a buyout depends on consistent cash flow”. The “opportunity” section of our analysis (whether this is a positive PV opportunity) includes the CUPID test:

• competition – can the competitors cause distress, changes in the industry. There shouldn’t be any innovation;
• unique – what is unique about this opportunity? If in an auction selling this firm why should we win?
• price – is the price low? Unlike the VC deals, where price didn’t matter and was easily “enhanceable” by the terms, in a buyout price is absolutely crucial! You absolutely cannot overpay!
• improvements – you have to be very certain about them;
• distress costs – probability and costs of financial distress should be low

[ok, this is some humor here] A buyout deal is like a cocktail party and that;s why you are called a sponsor – you are there to make sure that everyone in the party is enjoying himself = making the amount of money that they think is appropriate.

As a conclusion from our price discussion in the CUPID test valuation is relatively much more important than strategic analysis compared to the VC deals. Financial projections need to be constantly revised.

Structuring the LBO is straightforward: we have the purchase price which has to be multiplied by the typical percentages (specific to the size of the transaction) that different debt providers will supply. The residual has to be provided by us. Typical return expectations in an LBO:

• Senior / Term Debt – 6-9%
• Sub Debt – 10-15%
• Mezzanine Debt – 15-20%
• Equity – 25%+

Documentation – three main parts:

• term sheet between the private equity partnership and the management team;
• letter of intent – acquisition agreement;
• commitment letter – from the lenders to commit to put money on the table

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The only interesting key point of the case – BW/IP International was that acquiring this company made sense for “one of the best in the world” shops Clayton and Dubilier because they acquired a platform for further acquisitions, which would average down their purchase multiple. The transaction was a huge success – 18 CoC and enormous returns.