Implications of LBOing a high growth company
Can anyone provide any insights as to the likelihood of this? Why and why not either a financial sponsor or strategic buyer would do this. Thanks.
Can anyone provide any insights as to the likelihood of this? Why and why not either a financial sponsor or strategic buyer would do this. Thanks.
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High growth business generally have high CAPEX spend due to the necessary build out of infrastructure to support growth. For this reason, it's hard for a sponsor to do these types of deals as the cash flows normally used to service debt payments is being used to fund growth.
Not all high growth companies require significant capex, particularly Internet companies that can quickly scale. There could be many qualities that they may not be suitable LBO candidates, including existing shareholders not wanting to give up meaningful equity (effectively removing upside for themselves and losing control of the business) and lack of free cash flow to service debt (many successful Internet businesses don't generate positive FCF for years).
Strategic buyers could buy a high growth companies for also a host of reasons, including taking out a competition, entering a new market, entering a new category, staying relevant to consumers.
High growth companies, even if they're not Internet/tech low fcf companies also tend to have richer valuations because the expected growth is baked into the value. When you're doing leveraged deals IRR is better when the valuation is lower even if you enter and exit at the same multiple. Another risk is that you buy a company when it's on the upslope of the growth curve at a higher multiple and by the time you exit growth has slowed so the applicable multiple trends down. Buy high/sell low makes people sad.
There are tons of reasons why people don't lbo high growth companies though.
Happens all the time. See Growth capital and the stories of these ridiculous app valuations.
They shove in a bunch of mezzanine debt with control provisions and convertibility. It's still a debt instrument and it's still a LBO.
On a basic level, it is hard to be highly leveraged when the entry multiple is high e.g. if you enter at 15x EBITDA and get a lot of leverage (7x), you are still at over 50% equity contribution. This means the returns maths is often a little bit more challenging in high price/high growth. The can of course still be done but it is a slightly different model.
What type of acquisition would it become for a PE firm? Would PE funds still look at these opportunities or are these left for strategic acquisitions by competitors?
There are PE firms that do growth equity investments in which there wouldn't be so much leverage involved. If there is a compelling growth thesis, then you can still achieve attractive equity returns without leverage just based on the EV multiple expansion. OR, a PE firm could overequitize a buyout initially and then recap it with debt later on. I've seen a number of PE firms do this.
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