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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Introduction to Equity Dilution and Its Impact on Investors

Equity Dilution Definition: Occurs when a company issues new shares to raise capital, leading to a decrease in the ownership percentage of existing shareholders.

Founder's Perspective: Founders often face the decision of whether to retain complete control over their company or raise capital by accepting dilution, which can significantly impact their future earnings and control.

Key Stakeholders: Includes founders, employees, and investors who are all affected by dilution.

💡 Understanding the Mechanics of Dilution

Cap Table Management: A cap table tracks ownership percentages. New funding rounds can disrupt the cap table, reducing existing stakeholders' ownership.

Employee Stock Options: Commonly part of compensation packages in growing companies, often subject to dilution effects.

Investor Leverage: Investors with high demand for a company's stock can negotiate for favorable terms, minimizing dilution for founders.

🌟 Key Strategies to Minimize Dilution

Bootstrapping: Funding the business without external capital to avoid giving up ownership.

Strategic Capital Raises: Raising funds when the company is performing well to leverage maximum valuation.

Structured Shares: Implementing classes of shares (e.g., with voting rights) to maintain control.

🎯 Why Timing Matters

Critical Path Investments: Companies often raise capital in dire situations, leading to unfavorable terms for founders.

Market Dynamics: A company's performance significantly influences its negotiating power during fundraising rounds.

🔄 Balancing Control and Growth

Founder Autonomy: Utilizing founder shares and supermajority voting rights to maintain control even with minority ownership.

Employee Retention: Maintaining an adequate employee stock pool to attract and retain talent without excessive dilution.

🗨️ Expert Insights from Rory and Ed

Rory Liebhart: Highlights the importance of legal and financial advisors in navigating complex cap tables and negotiations.

Ed Barton: Emphasizes the strategic use of multiple funding rounds to enhance valuation and minimize dilution.

🔗 Essential Links

On-Ramp to Exit: Navigating Five Key Steps to Exiting Your Privately Held Business

The Exit Strategy Playbook by Adam Coffey

🚨 Conclusion: Managing Dilution for Optimal Outcomes

Risk Management: Understand the risks of each funding round and its impact on ownership.

Exit Strategy: Plan for the future with a clear exit strategy that balances growth and control.

Join us next time on the Private Equity Experience Podcast for more insightful discus

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.

Connect with Ed

Connect with Emily

Connect with Rory

Description:
In this episode, we explore the various types of funding rounds that a startup or business can undergo, ranging from angel investing to private equity buyouts. Our guests, Emily Sander and Rory Liebhart, are joined by Ed Barton, who shares his expertise on the private equity side.

Key Takeaways:
Angel investing: This refers to the initial round of funding, typically provided by high-net-worth individuals or family offices. It's a high-risk, high-reward investment, and the investor typically seeks a 10- to 20-fold return on investment.

Pre-Series A: This is the next round of funding, typically ranging from $0.5 million to $2 million, and involves a mix of high-net-worth individuals and institutional investors. Investors are seeking a 5- 10x return on their investment.

Series A: This is the first institutional round of funding, typically ranging from $5 million to $50 million. Investors are seeking a 5- 10x return on their investment.

Private equity buyout: This is a common exit strategy for businesses, where a private equity firm buys the company and takes it private.

IPO: This is another exit strategy, where the company goes public and is listed on a stock exchange.

Dilution and Cap Table Management:
Dilution occurs when the ownership percentage of existing shareholders is reduced due to the issuance of new shares.

Cap table management is the process of managing a company's capital structure, including the ownership percentages of various stakeholders.

Private Equity and Venture Capital:
Private equity firms invest in companies to acquire them and generate a profit through a sale or initial public offering (IPO).

Venture capital firms invest in early-stage companies with high growth potential.

Exit Strategies:
IPO
Private equity buyout
Strategic acquisition
Distressed sale

Lightning Round:

-Rory recommends the book "Barbarian Days" and the TV show "The Last of Us".

-Ed recommends the book "The Exit Strategy Playbook" by Adam Coffee and the novels by Amberlyn Murray.

-Emily recommends re-reading "The Martian" and "Project Hail Mary" on Audible.

The audiobook version of "On-Ramp to Exit" is available soon.

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.

Connect with Ed

Connect with Emily

Connect with Rory