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Take Five #049: How are PE firms funding billion dollar buyouts? ARR loans

1. How do you know if a deal makes sense or not? You need Gut Reaction Deal Math

What is Gut Reaction Deal Math?

When I was early in private equity, I was blown away by how fast the senior partners could determine if a deal made sense or not. They could look at a basic set of figures, do some mental math (informed by years of pattern recognition), and just know the multiple we could pay for the business.

As a searcher, you want to develop a sixth sense for “does this deal pencil?” as well. And it doesn’t have to take years or hundreds of deal reps because SMB deals are much simpler to underwrite.

This is primarily because lower price expectations + attractive debt financing via SBA means you only have to underwrite to the business not blowing up. Your underwriting can afford to be more downside-oriented than NEEDING the growth levers to work.

The post is fantastic, highly detailed, and includes a link to a Cash Flow Math Google Spreadsheet that you can copy and reference.

So I’ve laid that all out in a Google Sheet for you with three different columns so you can compare the math at different purchase multiples. It’s set to view-only, but you should be able to copy it into Excel or a fresh Google Sheet so you can mess with it.

Spend time with this sheet — tweak the assumptions, move the multiples around, change the deal structure, etc.

You should start to pick up on how the math changes as your multiple changes. Suddenly, a “3.5x SDE” deal doesn’t seem so good when it turns out to actually be a 4.25x EBITDA deal with high capex, meaning a very low DSCR.

From “Gut Reaction Deal Math” by Guesswork Investing

2. “If you’re in a Blue state, be open to searching out of state.”

An excellent breakdown by Thomas Ince of the key stats he looks at when evaluating a geo (in this example, Florida):

3. How are PE firms funding billion dollar buyouts? ARR loans

Loans based on recurring revenue are on the rise for PE firms, since the leveraged buyout market is frozen:

That [$8 billion acquisition of Coupa Software] deal, the 10th-biggest buyout of last year, according to Dealogic, was financed not based on profits, but on annual recurring revenue. Recurring revenue loans have been used for smaller software buyouts for years, but are being used more and more to fund some of the biggest technology takeovers, several private equity dealmakers told The Information.

Private equity firms are increasingly tapping non-bank lenders like investment firms for loans, and ARR loans are more of an option with those firms since they’re less regulated and risk averse than traditional banks.

The option of using ARR loans to fund bigger technology buyouts is key for private equity firms, which have been mostly unable to get loans from traditional banks for months. The banking industry has all but stopped funding private equity buyouts because interest rates have risen and the banks have struggled to offload the existing debt on their balance sheets.

At least 10 notable private equity deals were financed with ARR loans last year, compared to six in 2021, none in 2020 and two in 2019, according to data from LCD, a division of Pitchbook that tracks notable-–but not all—of these deals because the data is elusive.

From “Private Equity Firms’ Secret Weapon for Big Software Buyouts” by The Information (Editor’s note: there’s a paywall, unfortunately.)

4. The downsides to S Corps (a follow-up to last week’s S Corp explainer)

We featured part 1 of this thread last week, an excellent read:

5. The largest tech/software growth round ever in San Antonio goes to a holdco

Click into the tweet for the full announcement, but here are some sweet stats:

Starting in 2018, we've gone from two guys with laptops to...
* Owning 10 acquired software businesses
* 100s of employees across the globe
* 3,500 customers
* Strong brand in the industry
* $43mm in revenue

BONUS takeaway:

6. Why don’t more people buy profitable businesses from retiring owners?

Reddit thread on /r/Entrepreneur with 370 comments:

Assuming the business is cash flow positive, why aren’t more people buying them? Is it lack of knowledge or funds to secure them? So many retiring boomers with profitable businesses up for grabs and seems like no one is taking them? Why wouldn’t someone stuck in their 9-5s look at this as an investment strategy and put a manager in place? Get seller financing as well?

And some choice comments:

From “Why don’t more people buy profitable businesses from retiring owners?” on /r/Entrepreneur

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