LBO equity checks top 50% for the first time, thanks to high interest rates
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.