Debt-free deals see sharp rise in Q4

According to unquote" data, more than a quarter of the 237 buyouts completed across Europe in the last three months of 2008 contained no acquisition leverage, while in the beleaguered UK a staggering 40% of Q4 buyouts were all-equity deals.

Neil MacDougall, managing partner of Silverfleet Capital, suggests that the rationale behind many of these deals makes the "equity-only" tag misleading. "Sometimes the sponsor makes up the full enterprise value with equity as a form of short-term bridge financing while debt is being finalised; indeed some recent transactions have even been refinanced within three days of signing. Others deals are deliberately debt-free as some businesses have a lot of gearing already in their capital structure, particularly those with leasing on buildings and vehicles."

However, transactions of this nature do not account for the scale of the rise in debt-free deals. "Buyouts containing no debt are rarely a preference, but rather a result of the current banking market. Sponsors will invariably be planning to refinance; some within six months, but it seems more reasonable to aim for a 12 to 18 month window," explains David Ascott, head of private equity at Grant Thornton.

This tactic obviously carries a huge risk, as there are no guarantees that raising debt will be possible within this timeframe. Such deals will therefore remain unleveraged or have to be refinanced with more costly financing instruments such as asset-based or mezzanine loans; in either case severely impacting performance.

Moreover, there are obviously continuing uncertainties regarding company trading performance, which could have similar knock-on effects. "If the company underperforms then the assumed senior debt position becomes equity and this will obviously drag down returns," explains Ascott.

But with private equity being such a counter-cyclical industry it is precisely in the current environment that the most lucrative investments are historically made and there are already bargains on offer. With banks currently extremely risk averse and many distressed sellers likely to push for quick execution, exploiting these opportunities will invariably involve an increasing number of deals without leverage.

"People whose livelihoods depend on deals getting done are discussing equity-only deals at the moment because it increases the deliverability of the transaction. There are, however, greater risks for the investor and this needs to be reflected in the pricing," comments MacDougall.

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