Equity Contributions Continue To Grow

Purchase price multiples continue to deflate at a slower rate than lending multiples, forcing buyout firms to squeeze more equity into their deals.

“We’re almost at the point of paralysis in the financing world,” said Steven Miller, a managing director at Standard & Poor’s Leveraged Commentary & Data. “And the deals that are getting done tend to be very conservative, bear market-styled deals with 4x to 4.5x leverage, very low first lien leverage, high spreads and very big equity checks.”

Market-wide, equity checks in Q3 2008 represented an average of 43.8 percent of total deal structures, an increase from the average 39.9 percent overall equity in the second quarter, according to Standard & Poor’s Leveraged Commentary & Data, which recently came out with its Q3 purchase price and equity contribution figures for U.S. deals

In the middle market, which includes acquisitions of companies generating EBITDA of less than $50 million, the average equity check represented about 43.9 percent of the total deal structure, or 3.8x EBITDA—a modest increase over Q2’s 41.8 percent average.

In the large market, which includes acquisitions of companies generating EBITDA of more than $50 million, the average equity stake came in at 43.8 percent of the overall purchase price, translating to an average multiple of 4.3x EBITDA. That represents an average half-turn of EBITDA increase of equity per deal from the second quarter’s 3.8x EBITDA, when the average equity check accounted for about 40.1 percent of a deal, according to S&P.

Heavily-equitizing deals has become a necessity for firms looking to complete transactions in today’s barren debt market. It’s a more risky venture return-wise given that firms doing deals today have far more exposure to individual investments than they previously had.

Robert Brown, a managing director at investment bank Lincoln International, said some firms that are heavily equitizing today are doing so with the intent of infusing more debt into the company via a recapitalization six months to a year from now, virtually betting on a timely return of the financing markets.

“Some people are confident that they can swap the debt out in the future,” Brown said. “There is so much more money raised that they have to find ways to spend it. They’ll come up with more creative ways to go about putting their money to work.”

Brown said he believes overall equity stakes will continue to increase as the credit crunch plays out. And rather than seeing a decline in purchase price multiples that mirrors the decline in lending multiples, the market will likely experience a reduction in deal volume as firms pick and choose their over-equitized bets more carefully.