Private Equity firms are being impacted by the U.S. regulatory restrictions on highly leveraged buyout transactions. Recall that the U.S. regulators (the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency) first issued guidance in 2013 to try and make regulated lenders lessen their exposure to excessively leveraged M&A transactions. One part of the guidance forces regulated banks to strongly evaluate lending risks on, and avoid, deals where the Debt/EBITDA ratio would be greater than six (6). As a result, on several brand-name leveraged buyouts, regulated lenders declined to participate in the lucrative debt financing. Banks are up in arms because the regulatory guidance is unclear (and banks feel that certain regulatory organizations are more restrictive than others) and a number of regulated lenders are trying to be approved for returning value to shareholders so don’t want to run afoul of the unclear guidance. PE firms are upset that regulated lenders that often have long-term histories and valuable two-way relationships with the PE firms don’t want to participate in a proposed lending arrangement.
PE firms have reacted by doing a number of things. PE firms are reaching out to a greater number of regulated banks when pitching debt financing. PE firms are also turning to unregulated lenders for debt financing. PE firms are also working directly with debt investors. All of these strategies allow PE firms to maintain relationships with their regulated lenders while expanding the universe of potential M&A lenders (and hopefully lowering the costs of debt financing on their M&A transactions).
Another way to get around the Debt/EBITDA restriction is to recalculate the EBITDA of the target company by making various adjustments. Financial benefits to be derived from the buyout can be factored in to reduce projected expenses and thereby increase projected EBITDA. Target companies are having their financials scrubbed to see if any adjustments can be made to enhance EBITDA.