Introduction to Transaction Types

Introduction

What are Debt-Financed Transactions?

• Transactions that use borrowed capital to fund corporate activities
• Including acquisitions, ownership changes, and growth initiatives

Introduction

Key Dynamics:

• Leverage amplifies equity returns when transactions succeed
• But increases risk when performance disappoints
• Understanding transaction types, strategic rationales, and financing structures is essential

Leveraged Buyouts (LBOs)

What is an LBO:

• The acquisition of a company using significant debt financing
• Typically by private equity sponsors
• Debt usually represents 60-70% of the total purchase price, with equity providing the remainder

Leveraged Buyouts (LBOs)

Who Does LBOs:

• Private equity firms raise funds from institutional investors
• (pension funds, endowments, wealthy individuals)
• And use these funds plus debt to acquire companies
• They aim to improve operations, grow the business, and eventually sell it for a profit

Leveraged Buyouts (LBOs)

Basic Structure:

• An LBO typically uses multiple layers of debt
• Including bank loans (revolver, Term Loan A, Term Loan B)
• And sometimes bonds or mezzanine financing
• The sponsor contributes equity capital representing 30-40% of the purchase price

Leveraged Buyouts (LBOs)

How Returns Are Generated:

• Private equity firms make money three ways:
• Buying at reasonable prices and selling at higher multiples
• Improving company operations to increase profitability (EBITDA)
• And using cash flow to pay down debt over time, increasing equity value

Leveraged Buyouts (LBOs)

Typical Hold Period:

• Sponsors usually own companies for 3-7 years before exiting
• Through sales to other private equity firms
• Sales to strategic buyers (operating companies)
• Or taking companies public through IPOs

Leveraged Buyouts (LBOs)

Why Use Debt:

• Debt allows sponsors to acquire larger companies than equity alone would permit
• And leverage amplifies returns when transactions succeed
• Additionally, interest on debt is tax-deductible, reducing overall costs

Leveraged Buyouts (LBOs)

Target Characteristics:

• Ideal LBO targets have stable, predictable cash flows to service debt
• Strong market positions, opportunities for operational improvement
• And limited capital expenditure requirements

Strategic Acquisitions

What Are Strategic Acquisitions:

• Operating companies acquire other businesses
• To achieve strategic objectives such as entering new markets
• Acquiring technology or capabilities, eliminating competitors, or achieving economies of scale

Strategic Acquisitions

Strategic vs. Financial Buyers:

• Unlike private equity (financial buyers)
• Strategic acquirers are existing operating companies
• Buying businesses they can integrate into their operations
• They pursue synergies that financial buyers cannot realize

Strategic Acquisitions

Types of Synergies:

• Revenue synergies include cross-selling products to combined customer bases
• Or entering new geographic markets
• Cost synergies include eliminating duplicate overhead, combining purchasing power
• Or consolidating facilities

Strategic Acquisitions

Debt's Role:

• Strategic acquirers use debt to fund acquisitions
• While preserving cash for operations
• And avoiding dilution of existing shareholders through equity issuance
• Debt is often cheaper than equity and provides tax benefits

Strategic Acquisitions

Financing Approach:

• Investment-grade companies may use existing credit facilities, commercial paper, or issue bonds
• Companies with lower credit ratings utilize leveraged loans
• Similar to LBO financing, though typically at lower leverage levels

Strategic Acquisitions

Integration Importance:

• Unlike financial buyers who generally leave operations largely independent
• Strategic acquirers must integrate businesses
• Combining systems, eliminating redundancies, and merging cultures
• Integration success critically impacts whether the acquisition creates value

Strategic Acquisitions

Leverage Levels:

• Strategic acquirers typically use more conservative leverage than LBOs
• Investment-grade companies maintain 2.0x-3.5x debt-to-EBITDA ratios
• While lower-rated strategic buyers might reach 4.0x-5.0x
• Still below typical LBO leverage of 5.0x-6.5x

Growth Capital Transactions

What is Growth Capital:

• Debt (and sometimes equity) financing provided to established companies
• To fund expansion initiatives such as entering new markets, launching products
• Building facilities, or increasing working capital to support rapid growth

Growth Capital Transactions

When It's Used:

• Companies use growth capital when they've proven their business models
• And need funding to scale
• But aren't yet generating sufficient cash flow to fund growth organically
• It bridges the gap between venture capital and traditional corporate lending

Growth Capital Transactions

Typical Uses:

• Common applications include geographic expansion (opening new locations or entering new regions)
• Product development and launches, sales and marketing investments
• Hiring key personnel, acquiring equipment or technology
• And funding increased inventory or receivables as sales grow

Growth Capital Transactions

Who Provides It:

• Growth capital comes from specialized lenders including:
• Growth-focused debt funds, business development companies (BDCs)
• Banks willing to underwrite higher-risk lending
• And sometimes private equity firms providing both debt and equity

Growth Capital Transactions

Structure Differences:

• Unlike mature company financing based on historical cash flows
• Growth capital often includes revenue or EBITDA milestones
• Minimum liquidity requirements
• And sometimes equity warrants giving lenders upside participation if companies succeed

Growth Capital Transactions

Risk Profile:

• Growth capital carries higher risk than traditional corporate lending
• Because companies may not yet be profitable
• Business models remain somewhat unproven at scale
• And capital consumption continues during growth phases
• Higher risk translates to higher interest rates and additional protections for lenders

Growth Capital Transactions

Success Requirements:

• Growth capital transactions succeed when companies execute their growth plans
• Achieve projected revenues and margins, manage working capital efficiently
• And eventually transition to profitability and traditional cash flow-based financing

Key Differences Between Transaction Types

Buyer Type:

• LBOs involve financial sponsors (private equity)
• Strategic acquisitions involve operating companies
• And growth capital involves the existing company with capital providers as lenders (not owners)

Key Differences Between Transaction Types

Primary Objective:

• LBOs seek financial returns through ownership and eventual exit
• Strategic acquisitions pursue operational synergies and competitive advantages
• And growth capital funds expansion of existing businesses

Key Differences Between Transaction Types

Leverage Levels:

• LBOs typically use highest leverage (5.0x-6.5x EBITDA)
• Strategic acquisitions use moderate leverage (2.0x-5.0x)
• And growth capital often uses lower leverage or focuses on asset-based lending

Key Differences Between Transaction Types

Time Horizon:

• LBOs target 3-7 year exits
• Strategic acquisitions are permanent (indefinite hold periods)
• And growth capital typically matures in 3-5 years with expectations companies will refinance into traditional financing

Key Differences Between Transaction Types

Integration Requirements:

• LBOs generally maintain operational independence
• Strategic acquisitions require significant integration efforts
• And growth capital involves no integration (funding existing business expansion)

Conclusion

• Understanding these three fundamental transaction types provides foundation for evaluating debt-financed corporate activities

Conclusion

• Leveraged buyouts use maximum leverage
• To enable private equity ownership and generate returns
• Through multiple expansion, operational improvements, and deleveraging

Conclusion

• Strategic acquisitions by operating companies pursue synergies through business combination
• Using moderate debt levels to fund purchases
• While preserving balance sheet flexibility

Conclusion

• Growth capital finances business expansion
• For companies beyond startup stage but not yet mature
• Using specialized structures accommodating higher risk profiles

Conclusion

• Each transaction type serves distinct purposes
• Involves different participants
• And employs appropriate leverage levels matching specific risk-return profiles and strategic objectives