Leveraged buyouts, or LBOs, aren't looking so leveraged anymore. Private equity funds are ponying up more of their own cash this year than ever before to fund their deals — and using less debt.
Why it matters: It shows how the high interest rate environment is reshaping the economy and the way big investors deploy capital.
How it works: When private equity funds buy companies, they finance the purchases similarly to how individuals buy homes. They make a down payment — known as the equity contribution, which comes from the cash they raise from investors — and borrow the rest from banks or other lenders.
- PE funds tend to use as much debt as possible — this preserves cash for other deals and juices the funds' returns.
State of play: Debt's gotten pretty expensive this year, so the companies being acquired by PE firms can't afford as much of it.
- Loans to companies purchased by PE firms have yielded 11% on average at issuance during Q3, a record high, according to PitchBook LCD.
The impact: PE firms have been forced to use more of their funds' own money.
- Equity contributions are collectively around 51% this year, PitchBook LCD says — the first time that metric crossed the 50% threshold since the firm began tracking the data back in 1997.
- For comparison, the average equity contribution in the 10 years through 2021 was 41%.
The flip side: Leverage, or a company's ratio of debt-to-earnings, is now at a 13-year low for syndicated loans backing PE acquisitions.
- But, but, but: Even though debt is lower, interest payments are eating up a larger share of the earnings at LBO'd companies than they have since 2007, PitchBook data shows.
💭 Kate's thought bubble: Rates will (probably) come back down someday. And when they do, watch for PE firms to pounce, and take debt-financed dividends from these companies to recoup some of their cash.