Private equity is a difficult industry to break into but it can be an excellent source of income once you have the appropriate qualifications and experience. The following blog post will cover some of the ways that private equity firms finance their investments.
To learn more about debt financing in Private Equity, continue reading below:
Debt financing is a type of investment which companies or individuals can use to generate capital without taking on too much risk. We all know that there are many risks involved with investing in any type of company, but with debt financing those risks are lower as there is little to no risk for the investors as long as the company pays back its loan on time and in full.
Debt financing is also used to keep the company public while it continues to grow. This can be very useful when you are working towards an IPO or when there is a pending stock issue. Companies that use debt financing tend to trust their lenders more than they trust their own management.
The following are some forms of debt financing which you may encounter:
- LBO (leveraged buyout): This is the most common form of private equity financing used by companies and funds. The company issues a large amount of debt, usually 1-8x its current annual revenues, and then uses that money to buy the target company at a discounted price. While this allows for a quick and easy way to purchase equity in a company it also produces an enormous amount of debt for the target company. Once the deal has been completed, the acquirer(s) start loading up their balance sheets with as much debt as possible to pay off their investment as quickly as possible so they can turn around and sell the acquired company on Wall Street.
- Mezzanine debt: This is the most common form of debt financing used by private equity firms. It is simply a high-yield type of loan issued to the company in question. Like all high-yield investments, it can be very risky but it also offers a higher rate of return for the investor. The term of the mezzanine loan will differ depending on your investment but most are for between three and seven years. These loans are meant to be paid back with money from an additional round of financing or through gains made within that time period.
- Term loans: Term loans are another common form of debt financing used by private equity firms. Like mezzanine loans they are also high-yield, usually offering between 8 and 10% interest rates. These loans are typically paid back over one to three years at the end of the term period
- Loans with multiple covenants: Loans with covenants allow investors to capitalize on leverage by tying generous terms to the exercise of any of several key company options. Covenants track the ability to increase capital through equity or debt offerings, among others.
“This is an excerpt from our Fundraising section.” Fundraising is an essential stage in Private Equity investment. Businesses can gain a lot from raising capital, but setup and managing a raising properly is not a simple task. There are many issues to consider before taking this step, so you will need an experienced Private Equity team to assist you.