New in PE and former consultant. How do you determine what debt ratios are appropriate for a deal? Like I often see that when I run a mini model the debt coverage ratios are super stretched in Y1/Y2 but then ease off really quickly.
Also, the more debt you add the less equity you can allocate. While it boosts IRR the absolute return in cash will be lower, which can also be of concern in the current era of dry powder or am I mistaken?
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depends on your business, what lenders are ok with, and finally what your IC want. All else equal IRR rules given it's what determines carry and one of the main performance metrics for LPs
but everything around 70-80% is pretty sound. If you anticipate some revenue shocks to the business, this also should be considered on how much debt you could support to not trigger defaults. But this can be negotiated with tiered leveraged buckets in the agreements to get more debt overall and just pay additional when you surpass the ratios in those periods
if you say that in the first 1-2 years you see more debt, you can also negotiate an initial covenant holiday with the lender meaning that in the first period they can't enforce maintenance tests
otherwise if you fail in those you just reduce the debt until all sides are comfortable
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