Take the L out of LBO

August 31, 2009

In a perfect world, we would simply ban leveraged buyouts. The vast majority of these debt-laden corporate takeovers are no less predatory and value-destroying to a company than a loan shark who charges usurious rates of interest.

Realistically, a prohibition on private equity deals will never happen, given the big dollars involved in these transactions and the sizeable campaign contributions that private equity chieftains shower on politicians from both parties.

So here’s another way to prevent private equity firms from again saddling their corporate prey with too much debt: Prohibit banks from committing financing to any LBO where the private equity buyers are not willing to pony up at least 50 percent of the purchase price.

A 50 percent equity threshold would stop banks from giving in to their worst impulses, which are to do whatever they can to win favor with the private equity firms, in the hopes of rich fees and the promise of lucrative stock and bond underwriting deals down the road.

And it will force banks going forward to make more loans to companies looking to expand their operations and create jobs — not destroy jobs, as is often the end result of an LBO.

Requiring a private equity firm to put up a dollar for every dollar in a financing that a deal needs to get done is not as extreme as it may sound.

In fact, at the end of the two most recent LBO booms, it was not uncommon for the small number of deals that did get consummated to involve equity commitments in excess of 40 percent, according to data compiled by Standard & Poor’s Leveraged Commentary & Data.

Even in a dismal year for private equity deals like 2008, there were still more than 600 leveraged buyouts in the United States with a total value of $61 billion.

But with the credit markets sealed tight, the private equity players who orchestrated these takeovers had to dig deeper into their own pockets — coming up with the funds to cover some 42.6 percent of the average purchase price, according to Standard & Poor’s LCD.

By contrast, during the peak of the most recent LBO boom, the average equity contribution from private equity buyers was 33.6 percent in 2006. But there were some mega-deals — Clear Channel Communications — in which the private equity firms were able to put down as little cash as a subprime home buyer.

Now Clear Channel is struggling mightily with the mountain of debt the private equity firms loaded up on the company to complete the $19 billion deal. Overall, companies taken private by buyout firms are sitting on some $400 billion in debt, much of which needs to be repaid in the next five years.

Of course, the private equity firms will complain that a minimum 50 percent equity commitment will stymie deal-making and impact returns for buyout funds. That’s no doubt true. It’s a good thing, too.




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