debt paydown - PE transaction
can someone please explain to me whether it is most optimal to repay debt borrowed for a LBO transaction as soon as possible or to distribute as a dividend and pay down debt only when it falls due? generally based on a coverage ratio?
I thought it would have thought it would be better to pay a dividend, as it would increase your IRR, but curious as to why there is so much focus on debt paydown
thanks
As far as I know, it depends on loan/debt documentation. Generally under certain LBO financing cases, banks would expect (rather “demand”) cash sweeps up to 50-70% in initial years (provided cash is still available after mandatory debt service) to bring down outstanding balance so as to reduce refi risk at the end of the tenor. Hence if I’m not wrong, it’s not really up to the sponsor 100% of the times on whether to distribute excess cash flow as dividends or pay down debt with it
In addition to the post above - there's also the consideration of whether you want the debt headroom for something else in the future.
For example - if you're intending to pursue bolt-on acquisitions, it might make sense to paydown debt, and then use that capacity to fund M&A. It varies depending on what your LPA looks like, but most of the time once you distribute the proceeds to LPs, it can be hard to get the funds back because there will be time and size limits on recycling capital.
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