In the current environment, financing take-private transactions by private equity (PE) sponsors has been uniquely challenging. Volatility, inflation, rising interest rates, and geopolitical instability have all contributed to making equity and debt financing both more difficult to put together and more expensive. As such, typical private equity financing structures are being replaced with novel and more bespoke financing arrangements.
Despite the uncertain macro environment, private equity remains active, and there is significant dry powder available to be deployed. While fundraising has softened and aggregate capital raised declined in 2022, private equity powerhouses still managed to successfully close on big flagship funds. As PE players get accustomed to the new normal, 2023 is poised to see a resurgence in financial sponsor buying, but likely on new terms and utilizing new structures.
Private Equity Sponsors Are Less Willing to Write Large Equity Checks
Financial sponsors are less willing to write large equity checks to finance leveraged buyouts (LBOs). Unlike the beginning of 2022, when sponsors were willing to underwrite the full equity financing, private equity shops are now less likely to speak for the entire equity check and take on the syndication risk themselves. This development has been accentuated by the need for larger equity checks, as capacity for leverage in the market has shrunk dramatically and equity financing often now comprises a larger portion—sometimes north of 50%—of the overall sources and uses for a deal.
Club deals, which reduce individual equity commitments, are becoming more common, especially in sizable LBOs. For example, Hellman & Friedman partnered with Permira in June 2022 to lead a consortium of investors in buying Zendesk for $10.2 billion. In another notable deal in the software space, Datto was acquired by Kaseya for $6.2 billion, with funding from an equity consortium led by Insight Partners, with significant investment from TPG and Temasek.
As such, in large take-private transactions, careful consideration should be given to which private equity players are able to write the equity check necessary to execute the transaction on their own, versus which will need a partner. When running an auction and deciding when and how to pair up potential general partners, target companies and their advisors should be thoughtful about the potential impact of partnering arrangements both on the price a bidding consortium would be willing to pay for the company, as well as on the overall competitive dynamics of the sales process.
Sovereign Wealth Funds and Public Pension Funds Are Increasingly Playing a Key Role in Private Equity Transactions
Sovereign wealth funds (SWFs) have been very active in take-private transactions, and virtually no LBO of a meaningful size can be executed in the current environment without some level of SWF participation. The SWFs of Saudi Arabia, Singapore, Qatar, and the United Arab Emirates are on the list of desired limited partners (LPs)/co-investors of virtually every top-tier financial sponsor looking at a sizable LBO.
Canadian public pension funds have also become some of the world’s largest investors in private equity and are often on the list of requested LPs/co-investors. Many of them focus on investments in the infrastructure space, where they can generate stable returns commensurate with the expected payouts under pension plans.
While SWFs and public pension funds previously participated in private equity transactions passively, through their LP interests in PE funds, they have increasingly been coming in as co-investors alongside private equity firms, in roles with varying degrees of board and other governance rights. For example, in December 2022, Advent International agreed to acquire Maxar Technologies for $6.4 billion, in a transaction financed with $3.1 billion equity commitments from funds advised by Advent and a separate $1 billion minority equity investment by the British Columbia Investment Management Corporation.
Allocating LPs to bidders in a sell-side process is nowadays equally important as general partner (GP) partnering decisions, as LP access can be particularly relevant to the ability of certain PE sponsors to put forward fully financed bids, especially in mega deals. As such, putting together the right GP/LP investor groups can be essential for the successful outcome of auction processes, and decisions as to when to allow financial sponsors to talk to LPs—and which LPs they can have access to—carry significant weight.
In addition, the identity of LPs, the size of co-investor stakes, and the constellation of governance rights given to co-investors can dictate the scope of governmental clearances needed to close a deal, how long it will take to get them, and whether there is risk that they will not be obtained. This is something that can clearly weigh in the favor of—or, conversely, detract from the attractiveness of—any bid and should be given due diligence and factored in when making key strategic decisions over the course of auction processes.
Currently, Traditional Lending Markets Are Effectively Shut Down for Large LBOs
The syndication of the debt financing for the LBO of Citrix marked a watershed moment in traditional lending markets. For all intents and purposes, the big banks are not currently open for business when it comes to big LBOs.
In January 2022, Vista and Evergreen, an affiliate of Elliott Investment Management, agreed to acquire Citrix in a $16.5 billion LBO—the largest LBO of the year, setting aside Elon Musk’s purchase of Twitter. At the time, Vista and Evergreen had a $15 billion fully committed debt package ($16 billion counting the revolver) underwritten by a group of bulge bracket banks, led by Bank of America, Credit Suisse, and Goldman Sachs.
The debt was priced before the markets started souring and interest rates started rising in steep increments, and the banks had a difficult time offloading the debt. According to news reports, the Citrix bonds and loans were sold at big discounts to face value, and the underwriting banks ended up with more than $600 million in losses (and some junior debt remains unsold). Some commentators went as far as to label the Citrix debt sale “the point of no return” and a “bloodbath.”
The story of the Twitter acquisition financing is not that different. According to Bloomberg, in November 2022, Wall Street banks were sitting on more than $40 billion of buyout and acquisition debt that they were not able to sell following the dramatic turn in credit conditions earlier in 2022. Notwithstanding certain sales and block trades at the end of 2022, much of this LBO debt hangover still remains on bank balance sheets—which includes an estimated $12.5 billion of loans tied to the buyout of Twitter, as well as loans in connection with the acquisitions of Nielsen, Brightspeed, and Tenneco—and has significantly reduced banks’ appetite for more LBO financing in the near term.
Direct Lenders and Private Credit Are Taking the Place of Traditional Underwriters
The void created by big banks sitting on the sidelines of LBOs has been filled by direct lenders and other sources of private capital, particularly in the software and technology sectors. For example, a Blackstone-led group of direct lenders provided a record $5 billion loan for the Zendesk deal, and a private debt club led by Blue Owl Capital provided a $2.5 billion loan to finance Vista’s $8.4 acquisition of Avalara. Unlike traditional banks, who seek to place and sell committed acquisition financing to the debt market, direct lenders are in the business of holding the debt and are, unlike traditional banks, not under pressure to sell it.
Historically, direct lenders would often finance transactions on their own or in small groups. In recent deals, however, particularly for the larger LBOs, consortiums of direct lenders may include upwards of fifteen lenders. Direct lenders are credit focused and are known to do a deeper dive in diligence, as they are making the loans with the expectation of carrying them on their balance sheets until maturity. Direct lending debt packages may also be more expensive and contain bespoke features (such as a blend of callable and non-callable debt) designed to deliver lenders their desired returns. As a result, ironing out the details of a debt financing package can be more involved than in a traditional syndicated term facility and/or bridge to bonds. Direct lenders also have flexibility to provide alternative forms of private capital, notably preferred equity (typically combined with a direct lender debt financing or with a financing led by the traditional banks), which can give buyers greater flexibility, especially if rating agencies are willing to assign equity credit to the alternative financing.
Because of this, from the sell-side standpoint, it is important to ensure from the outset that the company has control over potential bidders contacting debt financing sources and that potential buyers cannot lock up debt financing sources in exclusivity arrangements without the company’s consent. In many deals, especially larger ones, competing private equity bidders need to go to the same universe of direct lenders (subject to customary “tree” and information barrier arrangements) to finance their bids, and locking up any debt providers can impede the competitiveness of an auction.
In addition, target companies and their advisors should be thoughtful about when to allow private equity firms to contact debt financing sources. Given the number of parties that would be brought under the tent, the risk of leaks should be considered and balanced against the need of private equity buyers to get perspectives from lenders to put forward firm bids and the need of lenders to have time to do their diligence and go through their investment committee processes to be able to execute binding financing commitments.
Auctions Need to Be Carefully Orchestrated from Beginning to End to Deliver the Best Value for Target Companies
For the reasons described above, from the outset of a sales process, target companies should ensure that they have full control over when potential buyers can contact equity and debt financing sources, who they can join forces with, and the basis on which they can engage with potential co-investors and lenders. These terms are often set at the NDA phase of a process and can set the stage for the entire auction. Some of the most crucial inflection points for the successful outcome of a sell-side process are the decisions regarding partnering, with the when, who, and how carrying significant consequences for the end result of an auction.
We wish to recognize, with immense appreciation, the assistance of Daria Butler.
Euromoney, After Citrix: Leveraged finance and the point of no return, December 22, 2022; Financial Times, ‘Bloodbath’: Citrix buyout debt sale casts shadow over pending deals, September 24, 2022. ↑
Bloomberg, Wall Street’s Hung Debt Swells to $43 Billion as Tenneco Closes, November 17, 2022. This $43 billion figure includes the Citrix debt, which, as noted in the article, was subsequently sold, but at significant discount. ↑
Bloomberg, Wall Street’s Lucrative Leveraged-Debt Machine Is Breaking Down, January 12, 2023. ↑