Private Equity Experience

Leveraged Buyouts Uncovered: Private Equity’s High-Stakes Game

• Emily Sander • Season 1 • Episode 15

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In Episode 15, hosts Emily Sanders and Rory Liebhart delve into the world of Leveraged Buyouts (LBOs), examining how private equity firms and other entities utilize substantial debt to acquire companies. Joined by expert Edward Barton, the conversation examines the mechanics of an LBO, its benefits and substantial risks, including cash flow pressure and covenant breaches. The episode also addresses why the current private equity market is experiencing a "log jam" due to factors like high valuations from past years and rising interest rates.

Key Takeaways & Discussion Highlights (Leveraged Deal Structure)

What is an LBO?
An LBO is a private equity funding strategy where a significant portion of the purchase price is financed through debt. The acquirer uses the target company's future cash flow to service the loan (12:01, Rory).
Example: A private equity firm paid ~$50M + ~$140M debt for a business with $11-13M in annual free cash flow (12:01, Ed/Rory).

The Players in an LBO & How They Make Money

Private Equity Firms: Profit through appreciation (sale at higher valuation), dividends (cash distributions - corrected later in the episode), and management fees (20:22, Edward; 23:37, Emily/Rory).

Company/Sellers: May use an LBO if the buyers (often PE firms) need a loan to close, sometimes offering a quicker exit or a multiple on EBITDA (21:07, Edward).

Lenders/Banks: Earn interest payments and fees (warrants/loan fees may be required). Crucially, they often control the company's cash flow through restrictive covenants and account control agreements (19:17, Emily/Rory, 25:06, Rory). Defaults can lead to forced sales or bankruptcy filings (25:42, Ed/Rory).

Benefits of LBOs

High Returns for PE: If executed well, debt allows leveraging a smaller equity investment into a larger holding, potentially increasing returns (20:37, Edward/Rory).
Opportunity for Turnaround: Skilled management can restructure ("staple down" goodwill) and grow the business, repaying debt and realizing the equity gain (*28:02, Edward). (Example: debt-financed turnaround selling back to seller, or using debt to fuel growth).

Significant Risks and Challenges

Refinancing Risk & Maturity Shock: Large balloon payments due at specific dates (Term Sheets) if the hold period ends without selling or refinancing (13:28, Ed, 15:44, Emily).
Covenant Burden: Strict financial covenants (audited at least annually) requiring operational excellence. Failure to meet them ($0.99EPS negative?) can trigger costly refinancing or sale (15:44, Emily, 25:42, Ed/Rory). Being "greased by deals?" Ask about amortization.
Personal Guarantee Risk for Management: Founders or leaders can sometimes personally guarantee debt, linking their personal financial health to the business outcome (19:49, Rory, 23:16, Edward).
Cash Flow Dependence: Requires consistent EBITDA to service interest payments, lessening flexibility (21:07, Edward, 26:42, Ed). Low EBITDA increases the risk of default (*31:25,Rory).

Who We Are

If we haven’t met before—Hi! We’re a team of professionals who’ve worked together at multiple companies, seen private equity from all sides, and are here to share what we’ve learned to help you succeed. Ed Barton brings decades of tax and financial strategy experience; Rory Liebhart is a finance and M&A pro with a track record of high-growth exits; and Emily Sander is a former Chief of Staff, multi-time author, podcast host, and founder of Next Level Coaching, helping leaders and organizations accelerate their growth.


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emily-sander_1_06-17-2025_160326:

all right, let's see. Icebreaker question for now. If you had to describe the current state of private equity in one emoji, what would it be?

squadcaster-67f2_1_06-17-2025_160323:

I'm, I'm not gonna say fire, like a, like a dumpster fire'cause it's not, but uh, yeah, I think, um, pensive perhaps, you know, that

sweet-eddie-b--it-_1_06-17-2025_160325:

It is

emily-sander_1_06-17-2025_160326:

Mine would be the one with like the big eyes where it's like, uh.

squadcaster-67f2_1_06-17-2025_160323:

could be.

sweet-eddie-b--it-_1_06-17-2025_160325:

Yeah, no, I'm actually going with the one that's got just the two eyes no mouth. Like it's just a little round face with two eyes staring out at you. I, I don't, I mean, right now no one knows whether to be sad or happy. They don't know whether to frown or to smile, so there's no mouth. It's just two eyes, a little emoji with two eyes.

emily-sander_1_06-17-2025_160326:

Okay.

squadcaster-67f2_1_06-17-2025_160323:

investor in defense related, uh, contracts, I think you're probably smiling. All right. Just want, you

emily-sander_1_06-17-2025_160326:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

You might be right now.

squadcaster-67f2_1_06-17-2025_160323:

this, this goes where, I guess the dates where we're at, but you know, who knows? We might be at war with Iran another day or two. You never know. So.

emily-sander_1_06-17-2025_160326:

What is. No, let me, let's jump right in. So I was gonna do a hangover question, like true confessions. What's your worst hangover? But, um, we can save that for a later episode. I think I've witnessed Ed's worst hangover Dublin. Um, but we'll save that for a later episode. Uh, but we did run across an article more specifically by we, I mean, Rory came across as article. Just touch us off on that. Rory, what's, what's that saying?

squadcaster-67f2_1_06-17-2025_160323:

Well, it, it really is. Um, yeah, it kind of. It kind of summarizes what we've been talking about. You know, both in our podcasts, in our book to some degree is about basically liquidity in today's market and how a

emily-sander_1_06-17-2025_160326:

What's the headline of the article?

squadcaster-67f2_1_06-17-2025_160323:

just call the private equity hangover,

emily-sander_1_06-17-2025_160326:

The Private Equity Hangover.

squadcaster-67f2_1_06-17-2025_160323:

uh, basically what, uh, you know, what, what founders need to know about the$3.6 trillion exit log jam. So what that means is that there's a ton of businesses that are. Actively being held by private equity groups, venture capitalists, et cetera, that have not transacted, meaning they're getting the whole period's long. there's so many reasons why people are holding onto these assets. Um, so mostly bad, but you know, a variety of reasons. It's just not as robust of a buy sell market right now as it has been in recent years.

emily-sander_1_06-17-2025_160326:

What is the long-term impact of that? If this keeps going.

squadcaster-67f2_1_06-17-2025_160323:

Well, it could be a lot of, a lot of things. Um, you know, not the least of which is people that invest in private equity funds that want to get their money back, they may have to sit on sidelines and wait longer. I.

sweet-eddie-b--it-_1_06-17-2025_160325:

I was gonna say on the, the private equity part of the component of private equity where private equity guys make their money is velocity because you want to have deals turning quickly. So you don't wanna hold'em too long.'cause you get, you get the realization of your upside on that. So from the. PE firm perspective. got your little two percents or one percents your care, you know, your kind of run along, um, that you get on an annual basis for management, but you really make your money on a transaction and that does two things. One, it puts money into. Private equity firms pocket. So they get a realized gain. They get a, as we've talked about on other podcasts and in the book you, they may get between 10 and 20% of the profit goes right into the general partner, the private equity firm's pocket. The second thing is they return that capital back to the to the limited partners who then invest in the next fund. And so if. If the entire system is kind of clogged up or you know, we've got private equity, constipation, and these deals aren't moving, making money. Nobody's able to reinvest'cause there's no liquidity at the limited partner line, so they don't have the ability to reinvest. And so the private equity guys don't have the ability to raise another fund and because they don't have an ability to raise another fund, there's no money available to be able to go buy the stuff that's on the market. And it just clogs everything up.

emily-sander_1_06-17-2025_160326:

So there's this cadence that it has to run at, and this is like log jamming, that cadence, and it's clogging it up. We need Metamucil, we need to take some Epsom salt baths. We need to get, get the logjam through whatever analogy we wanna use. Because like, my question is if that continues for long enough, does it just does something just die? Like what? Like, does private equity go away?

sweet-eddie-b--it-_1_06-17-2025_160325:

end up happening, I, from my perspective, is you'll get to, there's a reason why nothing's moving. And it's, it's a liquidity issue. So there's a liquidity issue where, you know, folks are looking at the liquidity. They have their ability to put stuff back to work. The, yeah, it just doesn't make sense to pull the trigger. At some point, someone needs to get liquid, the price will, prices will start coming down to where folks go. Okay. I, regardless of kind of where I'm at.

squadcaster-67f2_1_06-17-2025_160323:

Yeah. I

sweet-eddie-b--it-_1_06-17-2025_160325:

This makes sense. I'm pulling the trigger I'm gonna buy Now. The issue is when you've got the buy, when the buy sell spread on these transactions, which is really what we're seeing right now, is there's a buy sell spread that's fairly large. The sellers bought as, as we talked about earlier, the sellers bought. Or the, the, the, when the sellers bought in, they bought in, you know, five years ago to today, which is, you know, I was sitting in the market going, I can't believe people are paying these multiples and companies are trading at ridiculous prices. And during COVID, you know, it seems like everybody was overpaying for everything.

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

now

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

folks are, they're looking to sell. Their basis in those assets is very high.

squadcaster-67f2_1_06-17-2025_160323:

Mm-hmm.

sweet-eddie-b--it-_1_06-17-2025_160325:

Now what we've seen is interest rates have risen. So the risk premium goes up, and so as a result, you've gotta'cause,'cause again, you've got your risk-free rate has gone up. So the risk premium above that has gone up. So the prices come down and there's a gap between this is what I paid for it, this is what I modeled my return to be, or this is what I booked my valuation as. And this is what the market's willing to transact based upon the current profile of kinda risk, premium, and discounted cash flow.

emily-sander_1_06-17-2025_160326:

So basically like you're taking a loss.

sweet-eddie-b--it-_1_06-17-2025_160325:

It, it could be, it could be a, it may not be a loss from the initial investment, but it may be a

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

lower than expected return to either the limited partners, the general partner, or both.

squadcaster-67f2_1_06-17-2025_160323:

Yeah, I mean, cash is king right now too, so that's another thing with private equity, you know, and we talked about private credit in our last episodes. Typically those two go together. But, you know, um, I'd say in terms of deal flow, the groups that have the advantage right now to buying companies are probably strategics, like large, large corporations that. Have an acquisition strategy as part of their ethos. And so there's maybe not as much competition, one might say, um, against private equity and others that maybe rely a lot on leverage. Uh, with Ed, talked about it, you know, interest rates are high. They were pretty much zero, um, risk-free rate four or five years ago. you're looking at 7% interest rates plus on just like a paper. And so, you know, um, whereas. know, strategics may not have had as much of an upper hand on private equity in a lot of ways. Now they, they may, uh, there's just not as much competition for deals probably. And then flip it on the other side. talk a lot in this podcast, in our book, et cetera, about founder perspective, right? So if you're a founder that's built your business and you've been wanting to transact, you've been wanting to sell your business, or you thought five years ago, Hey, if I grow this sucker five years from now, I'm gonna trade it and a massive multiple on my EBITDA or revenue, or however you wanna. Build that valuation. Um, you're probably rerunning your models these days on, you know, what that looks like, and you might not have as much option you did before. So you're probably forced with the idea of do I continue to bootstrap this thing? Do I continue to look at taking on or the investors, whatever. Uh, maybe you take pay for expensive debt, who knows? But, um, maybe you're, rethinking things now when, when you, uh, you know, had a different vision four or five years ago.

emily-sander_1_06-17-2025_160326:

So you mentioned leverage, you mentioned taking on debt. Does a a leverage buyout help you in this scenario?

squadcaster-67f2_1_06-17-2025_160323:

Does it help you? Uh, that depends on a lot of things, I guess. Uh, what are the terms of that debt? What's the cost of that debt, you know? Um, does the

emily-sander_1_06-17-2025_160326:

If we zoom out, what's a, if we zoom out what's an LBO?

squadcaster-67f2_1_06-17-2025_160323:

Oh, it's just simply using debt to finance the purchase of a, an asset a company.

emily-sander_1_06-17-2025_160326:

if, so, if you don't have cash,

squadcaster-67f2_1_06-17-2025_160323:

Yep.

emily-sander_1_06-17-2025_160326:

you can finance this thing through debt.

squadcaster-67f2_1_06-17-2025_160323:

Yeah, that's right.

emily-sander_1_06-17-2025_160326:

Okay.

squadcaster-67f2_1_06-17-2025_160323:

And

emily-sander_1_06-17-2025_160326:

just,

squadcaster-67f2_1_06-17-2025_160323:

the, that's the common, common playbook used by private equity firms is, and they're

emily-sander_1_06-17-2025_160326:

hmm.

squadcaster-67f2_1_06-17-2025_160323:

with banks that they're really familiar with, um, private credit funds that they're really familiar with. And, and it really allows them to put equity down, um, minimum loan cash down at close, know, in typical terms, you're able to use the cash flows from the business to service that debt over time. then you think about it in a private equity hold period scenario, you know, call it three to seven years, you know, you structure well, you're, you'll either refinance that debt out to, um, better terms, or you'll basically transact the business within that timeframe before the debt's mature. But I think right now a lot of the businesses are having to face restructuring their debt because they hadn't previously, um, you know, sold the company, the op, the asset. So it's like, all right, well I gotta pay, I gotta bullet maturity on my debt facility. I gotta deal with that. And so maybe they're not getting as much as Ed talked about, um, good economics on their, their whole situation right now.

emily-sander_1_06-17-2025_160326:

Okay, so, so, um, give me an example of an LBO. So at the beginning, I don't have cash, so I might pay, I don't know, I'm making up numbers. Like let's just pick simple numbers, like 1 million in cash and then I'm taking on X amount

sweet-eddie-b--it-_1_06-17-2025_160325:

depends. So XX is a variable number and it really depends upon the free cash flow of the target. So what you're looking, what you're looking for, essentially. So I'll, I'll use an example, um, a a real life example. So you have a, a company that Roy and I worked with that just spun cash like crazy. So when you look at the, when you look at the. Kind of the debt-free at, so you look at the balance sheet, you look at the assets, and you, you have it, just no liabilities. You look at the assets and it's got a hundred million of assets and that a hundred million of assets is, is spinning, you know, 11, 12,$13 million of free cash flow on an annualized basis. When the private equity guys come in to buy it, they go, okay, look, there, you got this a hundred million of assets, we're gonna pay you one 30 or 140 million. We're gonna put. 40,$50 million of equity and we're gonna borrow a hundred million

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

emily-sander_1_06-17-2025_160326:

Okay.

sweet-eddie-b--it-_1_06-17-2025_160325:

because the assets, they were, you know, it was a loan portfolios, the income coming off, those were more than service. The debt that's on the other side of the, that we used to acquire it. So, you've got on, on the other side, you know, and we were in a, a. Uh, business that they, that was a leverage buyout where they paid 50 million and put 14 million at debt on it and would check in for, for 36. And that was one where it wasn't the majority of the purchase price, but they said, okay, we could get good terms on this, on this note, and it makes our equity, it kind of juices our equity returns. So that's a leverage buyout too. It's just less leverage. The issue with that one, as you would call. Is, as Rory just noted, the, there's a bullet maturity. So basically what that says is, you know, the loan pays off a little bit every quarter, five years in because the guy said, well, five years we'll have sold this if five years in the entire balance is due. So it may have been paying down a million dollars a year. For five years on a$14 million note, and then all of a sudden at the end of year five, they gotta stroke a check for 9 million bucks. Well, if they don't

emily-sander_1_06-17-2025_160326:

Oh no.

sweet-eddie-b--it-_1_06-17-2025_160325:

million, then they've either gotta refinance the debt under, under duress or sell the business to raise the, to raise the money, or they've gotta do a capital call

squadcaster-67f2_1_06-17-2025_160323:

for

sweet-eddie-b--it-_1_06-17-2025_160325:

and put more capital in.

squadcaster-67f2_1_06-17-2025_160323:

Yeah, yeah.

emily-sander_1_06-17-2025_160326:

Okay, so let me recap what I think I just heard. Leverage buyout is a strategy. It's an acquisition strategy. You can use many strategies to get in, but okay, so you're taking on a significant amount of debt, like ballpark, like is this anywhere from 60% to 90%? Is that a gen?

sweet-eddie-b--it-_1_06-17-2025_160325:

could be anywhere from 25, generally 25% to 75%. You tend not to,

emily-sander_1_06-17-2025_160326:

Okay.

sweet-eddie-b--it-_1_06-17-2025_160325:

effectively don't see much above that in the market where they're borrowing a hundred percent or 90% of the purchase

emily-sander_1_06-17-2025_160326:

Okay,

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

emily-sander_1_06-17-2025_160326:

so this, this makes sense if you have a cash rich asset

sweet-eddie-b--it-_1_06-17-2025_160325:

flow.

squadcaster-67f2_1_06-17-2025_160323:

so.

emily-sander_1_06-17-2025_160326:

and private equity uses this strategy a lot. The downside is if you run into these long hold periods, which we're talking about in this current market, you are. Term with the bank runs out and you owe a crap ton of money all at once.

sweet-eddie-b--it-_1_06-17-2025_160325:

Yes,

squadcaster-67f2_1_06-17-2025_160323:

and that's one risk on the other, of course, as we've talked about as well, covenants,

sweet-eddie-b--it-_1_06-17-2025_160325:

evidence.

emily-sander_1_06-17-2025_160326:

Oh.

squadcaster-67f2_1_06-17-2025_160323:

you, once you have, uh. You know, take on debt. You know, you're, you're, you're basically, you have to operate within a certain set of guardrails, which we call covenants. They're basically saying, if these, if these elements that are set in the credit agreement are not met, you know, there will be consequences of one, one sort or another. It could be just a financial penalty, it could be full acceleration of the facility, et cetera. There's a lot of, there's a lot of potential outcomes, but the point is, you know, if you have a debt facility, you know, you. Don't have as much margin for error with your business. Say something like, really problematic happens, you lose like half of your top customers, you know, for whatever reason could be a force majeure event. Who knows, could be anything. You're still on the hook to to pay back that debt on the terms of the agreement. Even if the disruption of your business means your revenue and your cash flows have gone down. So there's like real risk to this. I mean, leverage.

emily-sander_1_06-17-2025_160326:

I.

squadcaster-67f2_1_06-17-2025_160323:

means risk. I mean, leverage means. Uh, re you know, risk and return, but in some cases on the downside, it's, it's, it's pretty, it can be risky for sure.

emily-sander_1_06-17-2025_160326:

Well, I remember, like we, we've talked about, we're like, ed, you and I are the last company. Um. During COVID, I think, came into that situation where our, our revenue, we put them on hold.'cause we were trying to be nice to our clients. You don't have to pay us for three months, blah, blah, blah. But we got into a sticky, wicked situation with the bank because we were about to blow covenants. We were trying to renegotiate terms and they were like, we'll give you new term, new terms. But their, their rates and like their terms were just in a free fall here with revenue and you're, you're refinancing this thing, but the terms are atrocious. So they have huge leverage. They, they call the shots at that point,

squadcaster-67f2_1_06-17-2025_160323:

Well, it's very analogous to somebody today. Maybe like, that's pretty, you know, like let's say they have a home with equity in it, um, and, you know, but they lose their jobs or something like that, and they, they need to tap

emily-sander_1_06-17-2025_160326:

I.

squadcaster-67f2_1_06-17-2025_160323:

home equity, et cetera. Or they need to refinance their, their, their mortgage to tap into some equity. It's like, gonna pay, it's gonna cost you, you're gonna have to give up the. two and a half percent interest rate you've got on your mortgage and you're gonna have to go to market rates now, which is like six and half as of right now. yeah, you don't, you just don't wanna find yourself in situations where you've taken on debt. It's no different than in your personal life where you've taken on debt and you know there's disruption to your life or your business and, you know, it forces you to have, it forces your hand, um, to the lender.

emily-sander_1_06-17-2025_160326:

Question, is there a scenario where it gets to the point where it's better to declare bankruptcy to get debt off of your books?

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

Mm-hmm. Yeah. I.

squadcaster-67f2_1_06-17-2025_160323:

all the time. Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

I was, uh, I was making a comment as to a colleague yesterday, kind of doing a little reminiscing, uh, on, on, uh, a deal that I had worked on when I was, uh, over at Lone Star Funds, which was a, a accredited home lenders, which was headquartered outta San Diego. And they had, just prior to the housing crisis in 2008, they had acquired ames. Home Mortgage, which was a retail mortgage provider. So they had hundreds of commercial storefront leases across the United States. Then the mar the, the mortgage market stopped. They filled their warehouse'cause they, and they couldn't securitize. So basically they were stuck with a bunch of mortgages they couldn't continue to generate, and they had hundreds of storefronts that they were paying. Millions of dollars a month to to

emily-sander_1_06-17-2025_160326:

Yikes.

sweet-eddie-b--it-_1_06-17-2025_160325:

And the only way out of those leases unless you're gonna negotiate each one, is to file for chapter 11 now. And my recommendation was file this thing for chapter 11 and then 360 3 sale, essentially buy it out of bankruptcy and cleaned it up. Instead, they put additional capital in and then a year later filed for chapter 11.

emily-sander_1_06-17-2025_160326:

Oh no.

sweet-eddie-b--it-_1_06-17-2025_160325:

3 sale. Yeah. And bought it out. So, and, and that was, I was, that was the first time the private equity folks accused me of being defeatist because I didn't see that. But I, the defeat was actually, you know, I would've saved them, I would've saved them nine figures. Um, had they not gone through that process.

squadcaster-67f2_1_06-17-2025_160323:

Oh man.

sweet-eddie-b--it-_1_06-17-2025_160325:

But no one anticipated that the market was gonna be, again, constipated on the mortgage side that long, that it, they wouldn't be able to clear the warehouse.

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

emily-sander_1_06-17-2025_160326:

Okay, so, okay, so in LBO, who are the, who are the key players? You have the PE firm, you have the company,

sweet-eddie-b--it-_1_06-17-2025_160325:

Mm-hmm.

emily-sander_1_06-17-2025_160326:

you have the banks. Is there a better name for that? Like just

sweet-eddie-b--it-_1_06-17-2025_160325:

have the lender.

emily-sander_1_06-17-2025_160326:

lenders. Okay.

sweet-eddie-b--it-_1_06-17-2025_160325:

because sometimes it's banks, sometimes it's specialty lenders. Sometimes it's a bond issue. Sometimes it's a combination of all of those.

squadcaster-67f2_1_06-17-2025_160323:

Yep.

emily-sander_1_06-17-2025_160326:

Lender and then Are those, are those the main one, like the leadership team or Those are the main.

sweet-eddie-b--it-_1_06-17-2025_160325:

is not it. It has to manage, as Rory noted, you've got covenants and you've got all those things you gotta manage your way through.

squadcaster-67f2_1_06-17-2025_160323:

than any

sweet-eddie-b--it-_1_06-17-2025_160325:

is impacted. Leadership team is impacted, but hopefully the leadership team has not personally guaranteed any of this debt

squadcaster-67f2_1_06-17-2025_160323:

Oh my gosh. Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

and. They're not stuck in a position where, and that generally will happen when you've got a founder led business. Founders often are personally guaranteeing the debt of their business.

squadcaster-67f2_1_06-17-2025_160323:

right.

sweet-eddie-b--it-_1_06-17-2025_160325:

so, you know, hopefully the leadership team is not stuck in that position.

emily-sander_1_06-17-2025_160326:

So we have three main players. And then how do those players make money? Private equity firms the company appreciates in value.

sweet-eddie-b--it-_1_06-17-2025_160325:

Yeah, a company appreciates in value. So instead of putting a hundred million, so let's say the company goes from a hundred million in value to 200 million in value. The private equity guys, if they didn't have any debt on the books, went from, they made a hundred million dollars. They made a 100% return on their they investment

squadcaster-67f2_1_06-17-2025_160323:

Yep.

sweet-eddie-b--it-_1_06-17-2025_160325:

if they borrowed. A chunk of the money. So if they borrowed half of it, 50 million it paid back with the cash flow outta the business and they still sold it for 200 million, made four times their money.

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

But the, the key there is they have to have made cash flow from the operating business to pay off the debt because companies are sold on a basis of EBITDA generally. Normally debt free. when a private equity firm buys a company, normally you don't buy it subject to the existing debt. Normally there's a, a provision in the existing debt that calls that debt. Just like when you sell your house, you can't just sell your house and not pay off the mortgage. Same thing with most,

squadcaster-67f2_1_06-17-2025_160323:

Right.

sweet-eddie-b--it-_1_06-17-2025_160325:

most of these loan packages, if you have a change of control, the bank can call the debt, and so. if the cash flow is paid it off and they're selling it on ebitda, multiple EBITDA excludes all debt, excludes the impact of debt.'cause interest is excluded. So now they went from 50 million to 200 million and they used the cash flow from the company to pay off the debt. Now, otherwise, they might have been getting dividends. But the one

emily-sander_1_06-17-2025_160326:

Dividends.

sweet-eddie-b--it-_1_06-17-2025_160325:

yeah, the one thing that, that, uh, and we've, we've touched on it a couple times. You asked a really good question. And I, I kind of dismissed it and probably shouldn't have. The covenants have a, have a significant impact on the company's management team. Debt tends to cause it. What I will refer to since, since we've gone to a little bit of this type of, uh, type of analogy, it causes a little bit of a pucker factor associated with the, with the, uh, with the management team because you, you now have basically the big bag bank. Is who could take the company? Who can. So you've got this third party that's forcing you to run lean. You've got debt service which forces you to run lean. You don't have fat city cash flow anymore. And again, I've got, I've got an example where, you know, I was with a, I was a another Lone Star company. I was inserted, we did, they took a public company, private.

squadcaster-67f2_1_06-17-2025_160323:

Mm-hmm.

sweet-eddie-b--it-_1_06-17-2025_160325:

had a huge real estate portfolio that was all paid off, and we went and sale lease back. So we sold all of that, we leased it back, we borrowed a bunch of money, we dividend it out, all of that to the private equity guys and basically have this almost like. amount of debt and leases on a business that previously was run with five private jets with a bunch, like the company cars were all accurate as a Mercedes. Then all of a sudden you got nothing. I mean, you're lucky if we could, we, we were stretching to make the, make the lease payments every month and that's, that's keeps the management team focused on

squadcaster-67f2_1_06-17-2025_160323:

Yes.

sweet-eddie-b--it-_1_06-17-2025_160325:

execution.

emily-sander_1_06-17-2025_160326:

does.

squadcaster-67f2_1_06-17-2025_160323:

Aligned Uhhuh.

emily-sander_1_06-17-2025_160326:

Okay. Okay. So PE firms make money through appreciation, dividends and the management fees. in a, in the perfect world, when this is going well, that's how they make money. Okay. Lenders make money through I'm sure fees.

sweet-eddie-b--it-_1_06-17-2025_160325:

Fee.

emily-sander_1_06-17-2025_160326:

And like interest, interest payments.

squadcaster-67f2_1_06-17-2025_160323:

Yep. Fees and interest. Yep. Absolutely.

emily-sander_1_06-17-2025_160326:

Okay. Um,

squadcaster-67f2_1_06-17-2025_160323:

I mean, I'll throw it in there, sometimes there's some equity component. A lot of times lenders, depending on how early stage

emily-sander_1_06-17-2025_160326:

for the lenders.

squadcaster-67f2_1_06-17-2025_160323:

yeah, they'll take a, they'll take warrants as form of compensation, a warrant being an option to acquire equity. Basically an equity grant of sorts. Um, yeah, a

emily-sander_1_06-17-2025_160326:

Okay.

squadcaster-67f2_1_06-17-2025_160323:

of times they'll do that. If there's, especially now, I mean, I work, yeah, I work

sweet-eddie-b--it-_1_06-17-2025_160325:

Yeah. That comes down to when we, a couple, a couple, uh, podcasts ago, and we talked about private debt. They will, and we said that they'll often throw warrants in there

squadcaster-67f2_1_06-17-2025_160323:

Mm-hmm.

sweet-eddie-b--it-_1_06-17-2025_160325:

equity kickers in order to increase value. Well, that's, that private debt is also what's being used to fund. pro,

emily-sander_1_06-17-2025_160326:

Hmm.

sweet-eddie-b--it-_1_06-17-2025_160325:

buyout. So it may be that a bank, it's not a good, it's not a good, um, opportunity for the bank'cause they've got regulatory requirements that may, this may be too risky alone given their, you know, kind of their statutory regulatory requirements or their internal underwriting requirements. But a private lender's gonna come in and go, yeah, this is fine. But if you really hit away, I want my interest, I want my fees. A loan fee, a guarantee fee, uh, this fee or that fee, and another fee and a and a monthly, you know,

squadcaster-67f2_1_06-17-2025_160323:

Fee

sweet-eddie-b--it-_1_06-17-2025_160325:

service analysis, charge fee and put your, you gotta put your money here, but also at the end.

squadcaster-67f2_1_06-17-2025_160323:

So their cost of capital is extremely low, and

sweet-eddie-b--it-_1_06-17-2025_160325:

Yeah.

squadcaster-67f2_1_06-17-2025_160323:

they can lend it out at a bigger margin, net

sweet-eddie-b--it-_1_06-17-2025_160325:

Yeah.'cause the other, the other thing is normally the bank or lender will, will have what's called an account control agreement. And they control all your cash.

squadcaster-67f2_1_06-17-2025_160323:

Yeah. Yep.

emily-sander_1_06-17-2025_160326:

Hmm.

squadcaster-67f2_1_06-17-2025_160323:

Literally,

emily-sander_1_06-17-2025_160326:

so

squadcaster-67f2_1_06-17-2025_160323:

yeah.

emily-sander_1_06-17-2025_160326:

in the end, like they own this company.

sweet-eddie-b--it-_1_06-17-2025_160325:

the business and they,

emily-sander_1_06-17-2025_160326:

They own everything.

sweet-eddie-b--it-_1_06-17-2025_160325:

and they own the business. And as long as you keep making your payments, they'll let you

emily-sander_1_06-17-2025_160326:

They're fine.

sweet-eddie-b--it-_1_06-17-2025_160325:

Yeah.

emily-sander_1_06-17-2025_160326:

Yeah.

squadcaster-67f2_1_06-17-2025_160323:

to all the cash flow. That's what it comes down

emily-sander_1_06-17-2025_160326:

But as soon as they think like, these people can't run this business effectively, they're gonna,

sweet-eddie-b--it-_1_06-17-2025_160325:

it's not a, they think it's a, it's a you trip, a covenant.

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

a covenant and you don't cure fast enough, the loan becomes immediately due and payable. And

emily-sander_1_06-17-2025_160326:

then they.

sweet-eddie-b--it-_1_06-17-2025_160325:

can't write a check to pay off the loan right away. So then the bank has the ability to force you in a bankruptcy and take over the business.

squadcaster-67f2_1_06-17-2025_160323:

wonder how, how that, how, how frequently that if ever actually happens is like, you know, all

sweet-eddie-b--it-_1_06-17-2025_160325:

the bank, the banker.

squadcaster-67f2_1_06-17-2025_160323:

you're, I'm calling this, I'm calling this loan, and they're like, fine, fuck you. I'll just write a check. And they do it. Like how often can that happen? I wonder. I mean, it probably does from time to time, but like

sweet-eddie-b--it-_1_06-17-2025_160325:

I've, I've seen, I've seen a couple threats where, you know, the folks have said, I'm gonna,

squadcaster-67f2_1_06-17-2025_160323:

kind of threats. But yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

mean, we, I, I've been in one situation where the conversation was, okay, we'll toss you the keys. And normally they come back with a no, no, no, just, we'll, we'll do a covenant waiver or we'll change the covenants, but you gotta pay us a big fee.

squadcaster-67f2_1_06-17-2025_160323:

the one kind of point of, I guess, leverage, maybe not, not the right use of term in this case for a variety of reasons. But the one thing that we all generally know is that banks aren't in the business of, like, coming in and running operating companies. So

sweet-eddie-b--it-_1_06-17-2025_160325:

No.

squadcaster-67f2_1_06-17-2025_160323:

they don't want you to toss them the keys and say, come get it. so generally, you know, um, you work it out, but it can be an, a costly endeavor for the operating company, which, you know, from a, as you said, as I guess. As we incorrectly dismiss, that can impact management teams. If it's like all about, maximizing cash flow and things like that, you know, um, and, you know, in some cases people's bonuses are tied to company performance, which,

emily-sander_1_06-17-2025_160326:

Oh yeah.

squadcaster-67f2_1_06-17-2025_160323:

net income, may in some dumb reason, but like, you know, as opposed to EBITDA or something like that, like, dollar that goes out the door, whether you're paying for fees for, you know, um. Private jet flights or, you know, uh, uh, you know, fees for, for bank covenant waivers, then yeah, it's coming outta your pocket. So, yeah.

emily-sander_1_06-17-2025_160326:

Well, I've seen some like C-suite leaders, like mostly sales just get, like one of'em cried and one of'em just you could just see like he was deflated, when he knew his bonus was going down by 75%. He just like lost all kind of,

squadcaster-67f2_1_06-17-2025_160323:

that in salespeople. You want'em to be, uh, coin

emily-sander_1_06-17-2025_160326:

Yeah, but this can take this wind out of stuff, but yeah, and I remember

squadcaster-67f2_1_06-17-2025_160323:

especially good ones that are

emily-sander_1_06-17-2025_160326:

yeah,

squadcaster-67f2_1_06-17-2025_160323:

they, you know, this is a bit of a digression, but just general business is if a really coin operated, really high powered salesman, like feels like they're not gonna make any money, they're gone. You know, they're gonna go

emily-sander_1_06-17-2025_160326:

yeah. And I remember before I knew what covenants meant. I like you, ed and Rory and someone else at, at G two was having a conversation covenants. Covenants. And I could just see like everyone was super stressed. I had no idea what this meant. I had no idea what you were talking about, but I was this is serious. These people are not happy. This is super stressful for them. And like later on in different rounds and companies, I learned, I was like, I'm super stressed and I, and I have to be a buffer to my team. And everything's fine. Keep doing your stuff. You're doing great. But it's.

squadcaster-67f2_1_06-17-2025_160323:

have a good place in my heart.

sweet-eddie-b--it-_1_06-17-2025_160325:

compared to, compared to a couple of deals that I've been in. That one, that one.

squadcaster-67f2_1_06-17-2025_160323:

just gonna say that, ed, I mean all in all, I mean, was probably the, the company that had the tightest. Most predictable, uh, p and l and balance sheet light. Thank you actually to the sponsor who as, as you called out, didn't leverage that business up very much. It was like 33%,

sweet-eddie-b--it-_1_06-17-2025_160325:

Yep.

squadcaster-67f2_1_06-17-2025_160323:

Um, but in hindsight, that was probably the healthiest business I worked for, from a pure cashflow perspective straight away. I, I yearn for that again someday, know?

emily-sander_1_06-17-2025_160326:

And we'll end with Rory's yearning.

squadcaster-67f2_1_06-17-2025_160323:

equity though, like, and you know, we restructured that debt while we were there together, ed,

sweet-eddie-b--it-_1_06-17-2025_160325:

Yep.

squadcaster-67f2_1_06-17-2025_160323:

we did, we, we did what you usually can't do, which is out a dividend to sponsors while you're still in the deal. We, we did that because it

sweet-eddie-b--it-_1_06-17-2025_160325:

Yeah, we paid down, paid down. The accrued preferred, accrued preferred dividend, plus some of the preferred,

squadcaster-67f2_1_06-17-2025_160323:

yep,

sweet-eddie-b--it-_1_06-17-2025_160325:

it

emily-sander_1_06-17-2025_160326:

Yeah.

squadcaster-67f2_1_06-17-2025_160323:

Good thing, you know, for so many

emily-sander_1_06-17-2025_160326:

Okay.

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

emily-sander_1_06-17-2025_160326:

So, so one of the risks just to,'cause I'm trying to think this through. you take on a high debt load if you have a high percentage at the beginning, and the downside of that is there's less, there's less cash flow to work with. Like you have little, you have a little leash to work with versus if, hey, like we're gonna do this 25% at the beginning, then you have a little more room to operate in with cash. Is that.

squadcaster-67f2_1_06-17-2025_160323:

I just, yeah, I really like how, for the listeners out there that are not just. Swimming in the world that we're, we're swimming in here. Just to put it in your own world terms is like if you buy a house that's really expensive and you need to finance that, um, and your paycheck is a finite amount. Your, your, your, your, your mortgage payment takes up a bigger proportion of your paycheck. The higher the, the more house you're buying call it or. Take the down payment equation out of it for a second, but like you're choosing to take on more debt to buy a bigger house. You don't have to do it, but you're choosing to, which leaves you little margin for error on your other expenses that you have in your life and your pay, right? Same thing happens in business and that's actually one piece of advice I can give for most listeners that are not as plugged into the day-to-day as we are is like business is not that dissimilar to like your normal life, how you manage your checkbook, how you manage your. You know, proverbial checkbook anyway, um, how you manage your, you know, sheet, which is just all of the things you have versus all the things you owe. It's, it's really similar. It's just at a much bigger scale, generally speaking. So just think about things in those terms and use common sense basically.

emily-sander_1_06-17-2025_160326:

Yeah. Okay. Exit question. What breaks this log jam? Is it like interest rates? Is it you saying like valuations, we're just gonna give you what you want. Is it a whole different model emerging? What breaks the log jam? I.

squadcaster-67f2_1_06-17-2025_160323:

Well, interest rates, I'll say for sure. Um, you know, cheaper cost of capital means generally speaking, uh, people are more willing to borrow, to make things happen. Pretty much.

sweet-eddie-b--it-_1_06-17-2025_160325:

I think structurally, I think structurally interest rate lowering. I agree with Rory. I also think that that's. It's gonna be a tough, a tough ask given the current,

squadcaster-67f2_1_06-17-2025_160323:

a tough

sweet-eddie-b--it-_1_06-17-2025_160325:

the current macro economy and governmental squeezing out of the borrowing base. So I think the other, the other side of that is time will force transactions. You

emily-sander_1_06-17-2025_160326:

Hmm.

sweet-eddie-b--it-_1_06-17-2025_160325:

no choice, but at some point transact the business, the, the private equity folks and that those valuations, if they all come down and it's a macro factor. One thing private, well, the private equity guys will take it, will, will take it on the chin because, you know, they make money on the multiple up. You know, that's, that's a big component of their compensation. if everybody's suffering with it and everybody's gotta transact and everybody's gotta go through the process, private equity guys can at least look their limited partners in the face and go, this is a macroeconomic issue. It's not a US issue. And we're gonna transact this stuff, get liquidity, and we're gonna go buy in now that the prices have come down and you know, there's a lot of attractive opportunities out there. So I think if, if interest rates don't fall and I don't see that, you know, a dramatic change in interest rates, I actually see them probably continuing to tick up. Over the next, you know, five, five to 10 years, I think we're gonna continue to see rising rates just because of government debt requirements. I think the flip side of that is time is gonna cause these to transact and you know, they'll, they'll move on and you know, we'll hit reset

squadcaster-67f2_1_06-17-2025_160323:

Yeah. Yeah.

emily-sander_1_06-17-2025_160326:

Who, who wins in this economic environment?

squadcaster-67f2_1_06-17-2025_160323:

Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

They won.

squadcaster-67f2_1_06-17-2025_160323:

yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

They sold it. They sold at high valuations that aren't able to get replicated in today's market.

emily-sander_1_06-17-2025_160326:

Is this good for anyone else? If you're like contrarian, like, oh, this is.

squadcaster-67f2_1_06-17-2025_160323:

I think it's the, I think the big, the big companies out there that have a voracious appetite for acquisition, they win too. There's tons of cash sitting on balance sheets right now for the very reasons we're talking about. There's, you know, there, there hasn't been a lot of other avenues to spend. A lot of people are plugging money into, um, technology innovation, stuff like that, where maybe they were buying it through acquisition before. Now I'd say. You know, prices are going to go down. So if you have cash and you're acquisitive, you're gonna win. You know,

sweet-eddie-b--it-_1_06-17-2025_160325:

I think.

squadcaster-67f2_1_06-17-2025_160323:

you're buying good businesses, you know?

sweet-eddie-b--it-_1_06-17-2025_160325:

I think Rory hit it on the head earlier strategic buyers have largely been getting forced out by private equity buyers who were overpaying essentially. So the strategic buyers, they private equity was paying strategic buyer pricing. Assuming you know that there's gonna be a another upside, I think the real winner here is gonna be. The strategic buyer who can get cost synergies, who can get, you know, strategic synergies with those acquisitions, they're gonna be willing to pay more than the, than a private equity buyer. And the private equity buyer's now gonna be having to set their sites lower, and it'll be less competitive for the strategic buyer to be able to make some of these key acquisitions for their, for their corporate portfolio.

emily-sander_1_06-17-2025_160326:

Do you think this changes exit strategies or the exit environment forever? Or do you think like in a year or two. You, it'll go back to how it was.

squadcaster-67f2_1_06-17-2025_160323:

Boy.

sweet-eddie-b--it-_1_06-17-2025_160325:

don't see a year or two, but I do, and I, I do think, I actually think the last five to seven years have been more of an anomaly. if you look at the long,

squadcaster-67f2_1_06-17-2025_160323:

side. Yeah.

sweet-eddie-b--it-_1_06-17-2025_160325:

yeah, if you look at the long history, the long history is I. Private equity tends to buy smaller, undervalued businesses that are private, that aren't on a strategic radar. They grow them, they make them ready for institutional money or institutional purchase. Strategic purchase. Strategic buyers buy them, integrate them into their business, and then it's and repeat. Or they buy businesses that are larger and I'll use like the RJR and Nabisco. From back in the, back in the day, back in the eighties where the company is big fat and not being run effectively as a, as a public company. The private equity guys buy it, they strip it down, they put debt on it. They use all the tactics that we use today and then take it back public later. that's been the norm the last five years of private equity, flipping the private equity and you know, the prices going up and up and up has not been the norm. And so I do think. Instead of it being a permanent change, I actually think it's like back to kind of back to normal, um, for the industry.

squadcaster-67f2_1_06-17-2025_160323:

Yeah, I could see it. Yep.

emily-sander_1_06-17-2025_160326:

Final call. Anything else on current market or leverage buyouts? What they are, how to use them, what to think about?

squadcaster-67f2_1_06-17-2025_160323:

No, just. sensible choices. You know, uh, use, use common sense. If you, if you can't, uh, if you can't afford it, maybe don't buy it or finance it. You know, like it's, it is just, you know, simple principles I'd say, you know, look for value out there. That, that's the

sweet-eddie-b--it-_1_06-17-2025_160325:

Mm-hmm.

squadcaster-67f2_1_06-17-2025_160323:

If you have the wherewithal, there's value to be found, um, because of this lack of liquidity and lack of, uh, um, financing option for that. Yeah. Relative to what it has been in the last, call it five years or so. Yeah.

emily-sander_1_06-17-2025_160326:

I think apply Common sense is just a good life philosophy in

squadcaster-67f2_1_06-17-2025_160323:

answer.

emily-sander_1_06-17-2025_160326:

realms. Yes, love it.

squadcaster-67f2_1_06-17-2025_160323:

it defies, uh, defies things that

emily-sander_1_06-17-2025_160326:

Not a lot of people have it. Not a lot of people have it surprisingly. So that's a good one to end on. Apply common sense, apply judgment to all of your decisions, and we will catch you next time on the Private Equity Experience podcast. Thanks, ed. Thanks Rory.

squadcaster-67f2_1_06-17-2025_160323:

you.

sweet-eddie-b--it-_1_06-17-2025_160325:

Thanks guys.