Private equity firms may eventually have to change the way they do deals in the light of rising yields and the threat of a more widespread rise in interest rates.
But experts say this isn’t about to happen any time soon. Buyout shops finance acquisitions using a mixture of debt and equity – the higher the leverage, the more money they make on a subsequent sale. Fierce competition for deals and a benign debt market have pushed prices up to record highs worldwide.
The past few years have seen debt multiples rise to record highs as investment banks, desperate for a slice of the action and accompanying fees, have been offering debt at up to nine or 10 times earnings before interest, tax, depreciation and amortization.
But private equity firms are more sanguine and don’t expect buying or selling assets to be much of a problem any time soon. The funds have record amounts of money that have to be put to use, and they will continue to find creative ways to fund deals.
There is also little danger of distressed situations caused by over-leverage of portfolio companies in the short term, experts say.
This is because of the borrower-friendly debt terms already written into existing buyout deals, which means private equity firms effectively have more time to turn around a company.
A private equity firm can get a business right before the bank starts calling the shots – there are less triggers for the bank to call the loan.
There are also very few amortization terms in existing debt covenants, which means the principal amount in debt payments is lower, allowing companies to absorb minor interest-rate hikes.
Ultimately, there may be some moderation of over-exuberant lending, but there is no end in sight of the current deal-making.
