Thursday, December 28, 2006

LBOs Pile on the Debt - No Room for Error

In the latest M&A announcement that Harrah's is being purchased, private equity buyers Texas Pacific Group and Apollo Management have indicated that Harrah's will carry debt totaling more than eight times cash flow (as measured by operating earnings before interest, tax, depreciation and amortization - also known as EBITDA).

The December 27th Wall Street Journal (subscription required) comments that leveraged buyouts (LBO) of larger companies have involved piling on increasingly heavy debt loads. Fourth quarter LBO acquisitions have seen ratios of total debt to cash flow (or EBITDA) of 5.7 times on average according to S&P. This ratio is the highest it has been since the merger boom of the mid to late 1990s. With this much debt, a company has no room for error if interest rates rise or revenue and cash flow decline.

For a small business seeking to obtain a business loan, the analytical review is the same. Key ratios reviewed are the same as for the larger companies - total debt to EBITDA and EBITDA to debt service. However, the thresholds are tighter since there's even less room for error with a small business. For a small business, lenders typically won't allow a borrower to have total debt to EBITDA of greater than 3.0 times. These same lenders want to see that the EBITDA to debt service ratio exceeds at least 2.0 times.

Need help finding the right lender or telling your story the right way? Read "Matchmaking for Business Loans" and give me a call!

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