recap mm v22

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RESEARCH REPORT

September 2014

Review of Leveraged Finance Activity in Mid-Market Buyout Transactions

MARIO FISCHER

CHRISTOPH KASERER

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REVIEW OF LEVERAGED FINANCE ACTIVITY IN MID-MARKET

BUYOUT TRANSACTIONS

Mario Fischer Christoph Kaserer1

1 Christoph is a full Professor of Finance at Technische Universität München and Co-Director of the Center for Entrepreneurial and Financial Studies (CEFS), [email protected]; Mario is a research assistant at this institute.

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REVIEW OF LEVERAGED FINANCE ACTIVITY IN MID-MARKET

BUYOUT TRANSACTIONS

Abstract

Based on an extensive survey and data from PEREP Analytics, we show that equity contribu-tions in mid-market buyouts are higher and less volatile than in large buyouts. Regarding debt financing, which is mainly driven by boosting fund performance, non-traditional forms and small, regionally active banks become increasingly important. The implemented debt ratio is likely to be chosen from a trade-off theory model, in which the portfolio firm’s overall cost of capital is minimized. With respect to the financial crisis, we find higher borrowing costs for mid-market buyouts afterwards and an increased relevance of non-financial hurdles for raising debt. The latter is underlined by the crucial importance of the financial sponsor’s track record and the previous relationship with the lender to raise debt.

Keywords: Leveraged buyouts, private equity, debt financing JEL Codes: G23, G34 Acknowledgements Most of the data used in this study was provided with the helpful support of the European Private Equity and Venture Capital Association (EVCA). Moreover, financial support by the EVCA is gratefully acknowledged. The usual caveats apply.

REVIEW OF LEVERAGED FINANCE ACTIVITY IN MID-MARKET BUYOUT TRANSACTIONS 4

CONTENT

1. Executive summary ..................................................................................................... 6

2. Introduction ................................................................................................................. 9

3. Data collection ........................................................................................................... 12

4. Data analysis and results ............................................................................................ 13

A. Survey description .................................................................................................................. 13

B. Overall market trend in recent years ....................................................................................... 16

C. The role of debt in mid-market buyouts ................................................................................. 17

D. Sources of debt financing ....................................................................................................... 20

E. Internal drivers of debt financing ........................................................................................... 22

F. External drivers of debt financing .......................................................................................... 29

5. Outlook ...................................................................................................................... 32

6. Case Studies ............................................................................................................... 34

A. Overview ................................................................................................................................ 34

B. Norvestor buys Elixia ............................................................................................................. 34

C. Riverside buys Teufel ............................................................................................................. 38

D. HgCapital buys Visma ............................................................................................................ 41

7. Appendix ................................................................................................................... 46

References ......................................................................................................................... 51


LIST OF FIGURES

Figure 1: Development of European and North American buyout market ......................... 9

Figure 2: Structural information on survey participants .................................................... 15

Figure 3: Development of European private equity market from 2007 to 2013 ............... 16

Figure 4: Development of buyout market in Europe over the period 2007 to 2013 .......... 17

Figure 5: Financial structure in buyout transactions over the period 2007 to 2013 .......... 18

Figure 6: Financial structure in buyout transactions executed by survey participants ...... 20

Figure 7: Sources of debt financing ................................................................................... 21

Figure 8: Internal drivers of debt financing at the point of making an investment ........... 23

Figure 9: Internal drivers of debt financing after an acquisition ....................................... 25

Figure 10: Reasons for dividend recaps ............................................................................ 26

Figure 11: Constraints for dividend recaps ........................................................................ 27

Figure 12: Debt characteristics .......................................................................................... 28

Figure 13: Borrowing costs and non-financial hurdles ..................................................... 30

Figure 14: Percentage of regular amortization debt .......................................................... 31

Figure 15: Debt market outlook ......................................................................................... 33

Figure 16: Recapitalization outlook .................................................................................. 33

LIST OF TABLES

Table 1: Descriptive characteristics of survey participants ............................................... 14

Table 2: Overview of case studies ..................................................................................... 34

Table 3: Key figures of Elixia during Norvestor’s investment period .............................. 37

Table 4: Key figures of Teufel during Riverside’s investment period .............................. 41

Table 5: Key figures of Visma during HgCapital’s investment period ............................. 44


REVIEW OF LEVERAGED FINANCE ACTIVITY IN MID-MARKET BUYOUT TRANSACTIONS

1. Executive summary

I. In this study we analyze leverage finance activity in mid-market buyout trans-

actions.1 The results are based on an extensive survey that has been completed

by mid-market focused European private equity firms. Moreover, additional

data from PEREP Analytics as well as from other sources is used. Finally,

some of the results emerging from this study are further illustrated by a few

case studies.

II. As a first result we show that equity contributions in mid-market buyout trans-

actions are higher and less volatile than in large buyout transactions. While for

large buyouts the average equity contribution in the year 2007 was 21 percent,

we find a ratio of 32 percent in small and mid-market buyouts. Up to the year

2012, this ratio increased to 40 percent for the large buyouts and to 48 percent

for the small and medium sized buyouts. While these results are based on a

large dataset of buyout transactions provided by PEREP, a similar behaviour is

found for the transactions undertaken by the buyout firms participating in this

survey.

III. As far as debt sourcing is concerned, two results emerge from the survey.

First, non-traditional forms of debt financing become increasingly important.

In fact, almost 70 percent of the respondents state that debt funds have become

important. Also, over 50 percent of respondents agree that bonds and mezza-

nine instruments are becoming increasingly important. Second, as far as bank

1 For the purpose of this study mid-market transactions are defined as having a transaction size between 50 and 500 million Euro. Moreover, we distinguish between lower mid-market (50 to 100 million Euro), core mid-market (100 to 250 million Euro), and upper mid-market (250 to 500 million Euro). Buyout invest-ments refer to private equity transactions if the majority stake of a portfolio company is acquired. A lever-aged buyout (LBO) refers to the usage of debt in this acquisition.


financing is concerned, it turns out that about two-thirds of bank loans are

provided by smaller, regionally active banks. Large, internationally active

banks account only for 27 percent of the loans.

IV. When turning to the drivers of debt financing, survey participants strongly

agree that the leverage effect is fundamentally important in order to boost fund

performance. However, when looking at the decision about the specific debt

ratio, it seems that financial sponsors have a kind of a trade-off theory model

in mind, in which debt is chosen on the basis of negotiations with the debt

provider in a way that the portfolio firm’s overall cost of capital is minimized.

V. The approach to the financing decision changes considerably once the acquisi-

tion is finalized. In fact, for an existing portfolio company, debt acquisition is

mostly driven by the need for financing growth including bolt-on acquisitions.

Providing liquidity in order to finance repayments to shareholders, i.e. divi-

dend recaps, seems to be of less importance.

VI. When looking at dividend recaps more directly, it turns out that financial

sponsors use this instrument in order to provide short-term liquidity to the

shareholders of the portfolio firm and, as a consequence, to increase a fund’s

IRR. Overall, it can be said that for most buyout firms, dividend recaps are a

part of a long-term exit strategy.

VII. However, it simultaneously emerges from the survey that the degree to which

this instrument is used is constrained by the portfolio firm’s debt holders. The

increase in dividend recaps that has been experienced over the last months was

only possible because many debt holders took a more positive stance on these

recaps. According to the survey respondents, this is especially true for smaller,

regionally active banks. Simultaneously, it can be concluded from the survey


that this more positive stance was driven by an improvement in operating

earnings of the portfolio firms. In fact, in more than 60 percent of the cases the

leverage after the dividend recap in the portfolio firm was not higher than at

the time of the acquisition.

VIII. As far as external restrictions on debt financing are concerned, the survey

shows that for more than 80 percent of the participating buyout firms, borrow-

ing costs today are higher than they were in the year 2007. At the same time,

non-financial hurdles in debt financing have also increased since then. The

track record of the financial sponsor as well as an existing relationship with a

lender seem to be of crucial importance for access to debt financing. This is an

interesting result, as borrowing conditions for large listed firms as well as for

(some) governments have greatly improved since the year 2007.

IX. Despite this restrictive behaviour of lenders, the majority of the survey partici-

pants expect debt levels to further increase over the next 2 years. This is due to

the general improvement of the market conditions as well as to the availability

of non-traditional lending instruments. Moreover, the expected increase in the

profitability of the portfolio firms plays an important role here. Also, the re-

spondents expect increasing recapitalization activities by buyout firms over the

next 2 years. This is mostly due to the need for financing new growth opportu-

nities. Dividend recaps are expected to have a minor, but still not unimportant,

role in this regard. Pure refinancing of existing debt, however, should not be

an important driver for recapitalizations.


2. Introduction

With almost 50 billion Euro raised in 2013, the European private equity market almost

reached its all-time peak of 2006. Five years after the financial crisis, this marks a turning

point in the European private equity market. While the years 2009 to 2012 are character-

ized by rather limited fundraising activities, the European private equity market has re-

cently been catching up to the North American market, which already hit its bottom in

2011 and is growing since. As Figure 1 clearly shows the gap between the North Ameri-

can and European buyout market has narrowed over the last years. Despite the recent in-

crease in capital raised and newly founded funds, a further recovery and therefore growth

of the private equity market seems natural.

Figure 1: Development of European and North American buyout market2

The relative importance of the European market compared to the North American one is

clearly displayed in the committed capital and the number of newly created funds even

though this fact is not reflected in recent research.3 This explicit or implicit (through a

2 Data is provided by Preqin. North America shows all buyout funds based in North America with a North American focus. The same holds true for European buyout funds in this figure. 3 Two exceptions are Achleitner et al. (2010) and Diller and Kaserer (2009). Achleitner et al. (2010) focus on value creation drivers in European buyouts. They show that one-third of value creation is attributed to the leverage effect. This leverage effect is more prevalent in larger deals and in deals after the dot-com bubble. Diller and Kaserer (2009) investigate drivers of fund returns in a sample of European private equity funds. They are able to show that the so-called ‘money chasing deals’ phenomenon by Gompers and Lerner (2000) explains a significant part of private equity returns.


biased sample selection or simply the unavailability of appropriate data) focus on the

United States can also be seen by looking at the size of the scrutinized transactions. While

large buyouts gained a lot of attention, very little is known about mid-market buyouts.4

Also, debt financing mechanisms in private equity buyouts, especially as far as mid-

market buyouts are concerned, have not yet been extensively analysed in academic re-

search.5 Although, leverage is an important component in buyout transactions, investigat-

ing the underlying decision-making process has only recently been addressed.6 This paper

aims to make a contribution to these research questions by examining European mid-

market buyout transactions with a focus on debt financing.7

Besides the academic interest in filling those gaps, this study is also of practical rele-

vance. Several market-wide developments over the last few years, especially after the

financial crisis, allow for new insights based on very different market conditions. Two

major market-wide trends related to debt financing in private equity are the low interest

rates in Europe and international banks shrinking their balance sheets. On July 5, 2012,

the European Central Bank announced a drop of the base rate to 0.75 percentage points,

the first time it fell below 1 percent. Since then, the base rate has been further decreased.

Moreover, also the long-term interest rate dropped to historically low levels. In theory,

this should affect private equity firms because of lower borrowing costs and easier access

to cheap debt for buyout activities.

4 See for example Jenkinson and Stucke (2011). For an overview of leveraged buyouts as part of private equity, see Kaplan and Strömberg (2009). A comprehensive analysis of return attribution in European mid-market buyouts can be found in Kaserer (2011). 5 This lack led Cumming et al. (2007) to explicitly propose it as their fourth topic for further research. 6 Axelson et al. (2009), Demiroglu and James (2010), as well as Axelson et al. (2013) shed first light into the theoretical and empirical issues of the debt financing decision in private equity funds. Axelson et al. (2009) develop a theoretical model which chooses the financial structure to minimize agency conflicts. Demiroglu and James (2010) show a positive relation between buyout leverage and the private equity group’s reputation. The recent study of Axelson et al. (2013) is closely related to our investigation. They identify variation in economy-wide credit conditions as the most distinctive determinant of leverage in buyouts. Cross-sectional factors, which are suggested by capital structure theories, are not explaining buy-out leverage. 7 We do not consider performance of private equity funds in this paper. For studies on performance, see Kaplan and Schoar (2005), Phalippou and Gottschalg (2009), Diller and Kaserer (2009), Achleitner et al. (2010), Kaserer (2011), as well as Acharaya et al. (2013).


A second major trend is seen in the banking industry. As a consequence of the financial

crisis a comprehensive financial markets reform was put in place, which is yet not totally

accomplished. Most importantly in our context is the implementation of Basel III, which

puts additional pressure on large and international banks to shrink their balance sheets in

order to reduce their risk exposure. This may result in less domestic lending, especially as

far as seemingly more risky small and medium sized enterprises is concerned. Therefore,

SMEs could have problems getting bank financing at attractive interest rates despite low

interest rates.

By contrast, recent developments in European capital markets help these companies to

access other sources of financing. Notably, the corporate bond market for mid-cap com-

panies attracts attention in this context and allows those companies to replace bank fi-

nancing with proceeds from bond issues.8 Other trends that might affect financing deci-

sions during private equity buyouts include the decrease in mezzanine financing and the

rising popularity of unitranche debt financing. The latter at least partly offsets the former.9

All of the aforementioned developments have direct or indirect influence on private equi-

ty firms. This is especially true for funds which focus on mid-market buyouts. Therefore,

understanding the new market conditions and possible future impacts on the private equi-

ty business is valuable, not only for academia, but also for practitioners.

The remainder of this paper is structured as follows. Section 3 describes our multiple

sources from which we derive our data. Section 4 contains more information on our sur-

vey and our empirical results. In section 5 we give an outlook for future developments in

several focus areas of this study. Finally, section 6 illustrates some of our findings by a

few selected case studies.

8 See Lee (2013). 9 According to Preqin, the capital raised by European mezzanine private equity funds more than halved from in 3.3 billion Euro in 2012 to 1.6 billion Euro in 2013. For unitranche debt financing, see Porter (2012).


3. Data collection

In collaboration with the EVCA we were able to collect two data sets that will be used in

this analysis. First, from PEREP Analytics we have received information about the equity

contribution in a total of 6,759 buyout transactions with financial sponsor involvement in

Europe over the period 2007 to 2013. The overall transaction value of these deals was

more than 626 billion Euro. For every transaction, we also have the geographic area as

well as the industry of the target firm.

Second, together with EVCA, we have completed an extensive survey among mid-market

buyout firms. In this survey, we have collected information about the business focus and

structure of the private equity firm, the volume and financing structure of their transac-

tions before and after the financial crisis, the financing sources tapped, and the internal as

well as external drivers of the underlying financing decisions. A copy of this survey can

be found in the appendix in section 7. This unique hand-collected data set is the most im-

portant source in this piece of research.

Additionally, we provide some case study based evidence in order to illustrate some of

the core findings of this paper. Cases were provided by the EVCA and the private equity

firms involved. Case selection was mostly driven by data availability and, therefore, the

insights gathered from these cases cannot be claimed to be representative.

Finally, in some selected cases we add data provided by Preqin. This database gives an

extensive overview of private equity activity around the world and therefore allows

broader analysis. Because of regional and fund type filtering, Preqin is well-suited for our

research study. The incorporation of field data into our financial research might help vali-

date our results.10

10 As Soltes (2014) recently pointed out, this incorporation of field data into financial research might help to validate results and draw new conclusions.


4. Data analysis and results

A. Survey description

The survey has been answered by 21 private equity firms; all but one focus on mid-

market transactions. 11 All together these firms had a committed capital in their latest fund

of 14.8 billion Euro with an average of 741 million Euro per fund. In 50 percent of the

firms the size of the latest fund was below 336 million Euro. For comparison, Preqin re-

ports that 61 European buyout private equity funds with a total target fund size of around

40.9 billion Euro are currently raising money.12 The average and median target fund size

of those 61 funds is 670.0 million Euro and 240.9 million Euro, respectively. The differ-

ence in average and median fund size might be attributed to our focus on mid-market

funds compared to all funds in the Preqin database. If we limit those funds to a target fund

size similar to that of mid-market funds in our sample, we end up with 39 funds and a

total target fund size of 27.5 billion Euro. The average and median target fund size of

those 39 funds is 705.1 million Euro and 325.0 million Euro, respectively. This is very

close to our sample average and median values. Comparing the resulting 27.5 billion Euro

of currently raising funds to our sample value of 14.8 billion Euro allows us to conclude

that our survey participants cover a representative portion of mid-market buyouts in Eu-

rope.

Moreover, the average number of full-time employees in these firms was 54. However, 50

percent of the respondents had fewer than 22 employees. The average fund in our sample

has 19 portfolio firms, again with a lower median value of 14 companies. Table 1 summa-

rizes these descriptive statistics of the survey participants in total and divided by the par-

11 For the purpose of this study mid-market transactions are defined as having a transaction size between 50 and 500 million Euro. Moreover, we distinguish between lower mid-market (50 to 100 million Euro), core mid-market (100 to 250 million Euro), and upper mid-market (250 to 500 million Euro). Buyout invest-ments refer to private equity transactions if the majority stake of a portfolio company is acquired. A lever-aged buyout (LBO) refers to the usage of debt in this acquisition. 12 Data as of beginning of May 2014. Two additional funds are excluded because Preqin does not report a target fund size for these funds.


ticipant’s focus in size. Over all three mentioned characteristics, namely employees,

committed capital, and number of portfolio companies in the fund, an observable increase

in the average as well as in the median goes along with a larger focus in transaction size.

Specifically, private equity funds with an upper mid-market focus have more employees,

more committed capital, and are also invested in more different portfolio companies than

funds with a focus on lower or core mid-market transactions.

Characteristic Number of observations

Average Median Standard deviation

Min Max

Employees 21 52 21 61 6 250

... if lower mid-market focus 13 38 16 63 6 250

... if core mid-market focus 8 62 32 74 15 250

... if upper mid-market focus 5 135 106 71 42 250

Committed capital (in m€) 20 741 336 864 20 3,000

... if lower mid-market focus 13 429 250 547 156 2,300

... if core mid-market focus 8 871 485 700 223 2,300

... if upper mid-market focus 4 2,100 2,400 903 600 3,000

Number of portfolio companies 21 19 14 19 4 100

... if lower mid-market focus 13 18 12 24 4 100

... if core mid-market focus 8 27 19 28 8 100

... if upper mid-market focus 5 36 24 33 9 100

Table 1: Descriptive characteristics of survey participants13

As far as the structural information on survey participants is concerned, Figure 2 gives an

overview. It can be seen that geographic distribution is quite uniform throughout Western

and Southern Europe, with the exception of the UK, where 7 respondents are based.

Moreover, almost 80 percent of the firms are focused on lower and core mid-market

transactions, while fewer than 20 percent of the respondents also target the larger mid-

market tier, i.e. they are looking for transactions in the range of 250 to 500 million Euro.

13 Note that more than one focus is possible.


Also, two-thirds of the funds do have a regional focus, while only one-third consider

themselves as Pan-European. Interestingly, more than 80 percent of the respondents do

not have a sectoral focus. Finally, it is interesting to note that more than two-thirds of the

responding private equity firms do not employ a dedicated loan or debt market specialist.

This might be a first indication that financial engineering is not a major focus of these

mid-market private equity firms.

Figure 2: Structural information on survey participants


B. Overall market trend in recent years

In a first step we shed some light on the overall development of the private equity market

in Europe over the period 2007 to 2013. Thereto Figure 3 shows a similar pattern to Fig-

ure 1 with a substantial decrease in private equity activity from 2007 to 2009. In fact,

market size measured by transaction volume decreased by more than 90 percent; even on

the basis of the number of transactions, there was still a decrease of about 50 percent. In

2013, market volume was about 30 percent (by transaction volume), respectively 66 per-

cent (by number of transactions) of its size in 2007. The decline as a consequence of the

financial crisis is not only prevalent in aggregated transaction value and number of exe-

cuted transactions, but also in the linked average transaction size. After a drop of nearly

80 percent between 2007 and 2009, the average transaction size is currently close to 45

percent of what it was before the financial crisis.

Figure 3: Development of European private equity market from 2007 to 201314

Since the main focus of this study is the development of mid-market buyout transactions,

Figure 4 divides the transaction amount as well as the number of transactions depending

on their corresponding size categories. The aforementioned results are qualitatively the

same for all size categories. Even though the cyclical behavior of the buyout market can

be observed throughout all transaction sizes, it is also true that the small- and mid-market

turned out to be less cyclical than the large buyout market. Both measures of market

14 Data is provided by PEREP Analytics. In 2007, the overall transaction value in European buyouts was around 227 billion Euro distributed over a total of 1,349 transactions. This leads to an average deal size of around 168 million Euro in 2007.


development suggest a negative correlation between transaction size and transaction

activity in crisis.

Figure 4: Development of buyout market in Europe over the period 2007 to 201315

C. The role of debt in mid-market buyouts

This less cyclical behavior is also reflected in the financial structure of the transactions, as

can be seen from Figure 5. First of all, it should be noted that there was a substantial

change in the overall financial structure of private equity buyout transactions from 2007

to 2013. In fact, while in 2007 the average equity contribution in a European buyout

15 Data is provided by PEREP Analytics. In 2007 the overall transaction value in Europe was equal to 105 billion Euro distributed over a total of 1,349 transactions.


transaction was 38 percent, it increased to a maximum of 57 percent in the years 2009 and

2010. Afterwards, a decline in the average equity contribution was experienced. In 2013,

we had an average equity contribution of 56 percent.

Figure 5: Financial structure in buyout transactions over the period 2007 to 201316

However, the relative change in the equity contribution was much more pronounced in

deals above 500 million Euro transaction volume (large and mega buyouts) as compared

to small and mid-marked buyouts. In fact, for mega and large buyouts the value-weighted

average equity contribution in 2007 was 21 percent, while in 2012 this percentage in-

creased to 40 percent. In relative terms this is an increase of almost 100 percent. For small

16 Data provided by PEREP Analytics.


and mid-market buyouts the value-weighted average equity contribution was 32 percent

in 2007 and increased to 48 percent in 2012. This is a relative increase of 50 percent. In

2013, this trend vanishes since the average equity contribution of large ad mega buyouts

decreased to 32 percent. Moreover, in 2009, the equity contribution in small and mid-

market buyout transactions reached a maximum of 53 percent. It should be noted that the

equity contribution in these small and mid-market transactions is also consistently higher

compared with that reported in other studies.17

It is interesting to note that a similar time pattern can also be found in the buyout transac-

tions conducted by the survey participants. In fact, before the financial crisis the surveyed

private equity firms operated with an average debt to enterprise value ratio of 56 percent

as seen in Figure 6. Considering that some second-lien loans will have been used as well,

this seems to fit very well in the average equity contribution of 32 percent in the year

2007 reported above for small and mid-market buyout transactions. Since the financial

crisis, the ratio of senior debt has decreased to slightly above 40 percent. In relative terms,

one can say that senior debt in recent transactions was 73 percent of the volume it had in

the transactions conducted between 2005 and 2007, i.e. before the financial crisis.

Results are quite similar if one uses the debt to EBITDA multiple as a measure of lever-

age. In the transactions conducted by the survey participants from 2005 to 2007 this mul-

tiple was on average 4.2.18 After the financial crisis, it decreased to 2.8, while for the

more recent transactions it was 3. Moreover, cross-sectional variation decreased a lot.

17 Nikoskelainen and Wright (2007), Guo et al. (2011), Jenkinson and Stucke (2011), as well as Axelson et al. (2013) show average equity ratios of around 30 percent for their samples. A slightly higher equity ratio of around 40 percent since 1999 is reported by Ivashina and Kovner (2011) as well as by Cumming et al. (2007). This deviation might be due to several factors. First, we are focusing on Europe, whereas most of the aforementioned studies are heavily influenced by observations in the United States. Second, we mainly consider mid-market buyouts in contrast to a sample of large buyouts or the full size range of buyouts as used in other studies. Third, the studied period starts in 2007 and includes the recent financial crisis. All other studies stop at latest in 2008. 18 Note that this is lower than the average multiple of around 6 for the matching time period found in Axel-son et al. (2013). Again, this might be driven by their bias towards large buyouts and transactions in the United States compared to our European and mid-market focus.


While throughout the years 2005 to 2007, the maximum debt to EBITDA multiple was

7.4 and the minimum 1.7, for the recent transactions it varied in a range of 2 to 4.

Figure 6: Financial structure in buyout transactions executed by survey participants19

D. Sources of debt financing

As far as the sources of debt financing are concerned, some interesting results emerge

from the survey. First of all, it can be seen in Figure 7 that two-thirds of the bank loans

are provided by regionally active banks. Large internationally active banks account only

for 27 percent of the bank loans, while some loan contributions also come from non-

banks, like debt funds.

However, survey participants agree that non-bank sources of debt financing have clearly

become more important over the recent period. Actually, when comparing the debt

sources for the transactions conducted over the last 24 months with those that have been

done before more than one-third of participants agree that corporate bonds have become

more important as a financing source. Moreover, 17 percent agree that junior debt (e.g.

mezzanine) has also become more important. Hence, more than half of the participants

agree that non-traditional sources of financing are becoming more important. This is cor-

roborated by taking into account that almost 70 percent of the participants state that debt

funds are now a more important source of liquidity for portfolio investments than com-

19 Debt to EBITDA multiple is averaged over all survey participants.

0

2

4

6

8

2005-2007 2009-2011 Last 24 months

Debt to EBITDA multiple

Average Lowest Highest

56%

43% 41%

2005-2007 2009-2011 Last 24 months

Senior debt to enterprise value


pared to the situation before the financial crisis. That said, our participants have only a

limited interest in setting up a debt fund on their own.

Figure 7: Sources of debt financing

And finally, it is interesting to note that debt syndication has substantially lost im-

portance. While before the financial crisis, almost 50 percent of debt was placed via a

9%

10%

81%

Have you ever set up or planned to set up a debt-fund?

Yes, we have set up a debt fund

Yes, we are planning to set up a debt fund

No

27%

66%

6% 1%

In the transactions that you have executed over the last 24 months,

what percentage of the overall debt was provided by:

Internationally active (large) banks

Regionally active (small and medium) banks

Debt-funds

Issue of bonds

48%

22% 22%

2005-2007 2009-2011 Last 24 months

Percentage of debt from a syndication process

69%

23%

8%

In your opinion, have debt-funds become a more important source of

liquidity for your portfolio investments since the financial crisis?

Yes

No

Unchanged

22%

17%

35%

0%

17%

9%

Comparing the transactions over the last 24 months with those that you have done before, which of the following is true?

Loans have become more important as a financing sourceLoans have become less important as a financing sourceBonds have become more important as a financing sourceBonds have become less important

Junior debt (incl. mezzanine) has become more likely as a financing sourceJunior debt (incl. mezzanine) has become less likely as a financing source


syndicate, this ratio decreased to 22 percent directly after the financial crisis and did not

increase over the last 24 months.

E. Internal drivers of debt financing

There is an abundant literature explaining why firms take specific financing decisions.

This literature has also been extended to the financing decisions in the private equity are-

na. According to this literature, the most important factor driving the debt ratio is the use

of the leverage effect as a booster for fund performance. However, other reasons like tax

savings, using debt as a control instrument against the management of the portfolio firm,

or increasing fund diversification by reducing the equity stakes taken by the fund might

be important as well.20 The most related research to our study is conducted by Axelson et

al. (2013). They empirically examine the factors influencing the leverage in an interna-

tional sample of buyouts. Their results suggest that buyout leverage is mostly determined

by economy-wide credit conditions instead of cross-sectional factors proposed by tradi-

tional theories of capital structures.

According to the survey participants’ responses given in Figure 8, we corroborate the

perception that profiting from the leverage effect is the most important reason for raising

debt. However, aspects like increasing fund diversification by reducing the equity stakes

taken by the fund or profiting from the tax shield effect also seem to be important. A mi-

nor driver seems to be that debt exerts pressure on the management of the portfolio com-

pany.

20 Although Renneboog and Simons (2005) give an extensive overview of several empirical studies and the underlying theoretical considerations, we want to mention two recent articles on that topic separately, as they focus on leverage in a private equity context. First, Jenkinson and Stucke (2011) examine tax savings as a result of the increase in financial leverage. Since the use of leverage is available to all private equity firms and most large LBOs are executed in an auction with multiple bidders, they argue that ex ante pre-dictable tax savings benefit the vendor rather than the private equity buyer by being priced in the transaction value as a premium. Therefore, tax savings should benefit the existing owner rather than the private equity firm. They confirm this view by empirically showing a positive cross-sectional relation between tax savings and takeover premium. Second, Axelson et al. (2009) develop a theoretical model on the financial structure of private equity deals. In their model the financial decision reduces agency conflicts between the fund management and their investors. They distinguish between ex ante equity financing and ex post debt financ-ing in their model.


Figure 8: Internal drivers of debt financing at the point of making an investment

Now, while the answer to the fundamental question of why using debt might be advanta-

geous is clear, it is less obvious how the financial sponsor of a transaction determines the

specific leverage ratio. And, in fact, it can be seen from Figure 8 that this decision is driv-

en by a couple of different factors. Most importantly, it seems that the decision-maker has

1

2

3

4

5

At the point of making an investment, what are your primary reasons for raising debt? Please rate the following alternatives between 1 (totally

unimportant) to 5 (very important)

1. Quantile

Median

3. Quantile

1

2

3

4

5

At the point of making an investment, what is your typical approach to determining how much debt to raise for this acquisition? Please rate the

following alternatives somewhere between 1 (totally unimportant) to 5 (very important)

1. Quantile

Median

3. Quantile


in mind a kind of a trade-off theory model, in which debt is chosen in a way that mini-

mizes the overall cost of capital. Of course, as debt volume is always the outcome of a

negotiation with the debt provider, this goal may not always be completely achieved.

Nevertheless, a pure pecking-order theory model seems less appropriate, as maximizing

debt is not the primary goal of the financial sponsor. However, within the different debt

classes a kind of pecking-order seems to apply, as many participants have declared that

they try to maximize senior debt and, hence, avoid subordinated debt. Those results con-

tradict some of the conclusions made by Axelson et al. (2013) as they infer that funds

“often state that they use as much leverage as they can. This claim appears to be con-

sistent with the data.”21 An explanation for funds not trying to maximize the total amount

of debt might be their specific appetite for financial risk as seen in our survey. Therefore,

private equity firms might mainly consider the target’s overall risk, consisting of the im-

plemented financial risk as well as the target’s operational risk. This implies a more cau-

tious use of debt for target companies with high operational risk.

However, once a portfolio company is acquired, the approach to the financing decisions

changes considerably. In fact, for an existing portfolio company, debt acquisition is most-

ly driven by the need for financing growth including bolt-on acquisitions as can be seen

from Figure 9. Providing liquidity in order to finance repayments to shareholders, e.g.

dividend recaps, seems to be important as well, although it varies more within our survey.

By contrast, replacing existing debt or benefiting from market opportunities seems to be

of lower importance. However, if the decision to replace existing debt is taken, this is

primarily driven by the sake of reducing the cost of capital or extending the maturity of

the loans. As seen before, dividend payments to shareholders have some relevance.

21 See Axelson et al. (2013), p. 2264.


Figure 9: Internal drivers of debt financing after an acquisition

When looking at dividend recaps more directly, it turns out – as expected – that financial

sponsors use this instrument in order to provide short-term liquidity to the shareholders of

the portfolio firm and, as a consequence, increase the fund’s IRR. Cost of capital consid-

erations seem to play a minor role in this context as can be seen in Figure 10. From this

perspective, it is not surprising that dividend recaps are, at least to some extent, consid-

ered as being a part of a long-term exit strategy.

1

2

3

4

5

What are your primary reasons for raising new debt after the original acquisition debt? Please rate the following alternatives somewhere between 1

(totally unimportant) to 5 (very important)

1. Quartile

Median

3. Quartile

1

2

3

4

5

What are your primary reasons for refinancing existing debt with new loans? Please rate the following alternatives between 1 (totally unimportant) to 5

(very important)

1. Quartile

Median

3. Quartile


Figure 10: Reasons for dividend recaps

At the same time, however, it becomes clear that the degree to which this instrument is

used is constrained by the behavior of the portfolio firm’s debt holders. First of all, the

increase in dividend recaps that has been seen over the last months22 is, among others, due

to the increased willingness of debt holders to provide debt for this specific purpose, as

can be seen in Figure 10. Interestingly, this is a pattern that can be seen for all debt hold-

ers, even though it seems to be especially pronounced for small and medium sized banks.

We are not able to make an assessment of the appropriate time span between the buyout 22 See Tan (2014).

15%

54%

31%

How important are dividend recaps as a part

of your long-term realisation strategy?

Very important

Somewhat important

Not important

69%

31%

0%

Has the willingness of debt holders to provide debt for dividend recaps increased over the last 24 months as compared to the situation before?

Yes No Unchanged

12%

38%

0%25%

25%

If yes, for which of the following debt holders this is especially true?

Internationally active (large) banksRegionally active (small and medium) banksBondholders

Debt funds

All of these

32%

9%

14%

45%

What are your primary objectives in a dividend recap?

Maximize short-term payments to shareholders

Reduce portfolio firm’s cost of capital

Reduce fund exposure to portfolio firm

Maximize fund’s IRR

0% 17%

25%58%

What is an appropriate time span between the completion of a buy out

deal and a dividend recap?

Not important

12 months at least

24 months at least

Depends on the specific situation of the portfolio firm


and a possible dividend recap. It appears that this interval is case-specific and cannot be

generalized.

Not surprisingly, the willingness to finance dividend recaps has not increased uncondi-

tionally. In fact, it becomes clear from Figure 11 that in the vast majority, i.e. 63 percent

of the cases, the dividend recap was only possible because the leverage in the portfolio

firm has decreased as compared to the situation immediately after the acquisition. Ac-

cordingly, a large majority of the respondents agreed that the major hurdle for doing a

dividend recap is the relation to debt holders, because either it is difficult to getting access

to new debt capital or because covenant headroom will be lost and, therefore, the pressure

by existing debt holders will increase. Interestingly, incumbent management of portfolio

firms seems to be only a minor obstacle. Only 25 percent of the respondents mentioned

opposition by portfolio firm management as being a hurdle for doing a recap.

Figure 11: Constraints for dividend recaps

In addition to leverage and details about dividend recaps, we asked our survey partici-

pants about debt covenants and related costs. These results are shown in Figure 12. High-

er cash flows from operations and improved profitability are the two most pronounced

37%

50%

13%

What percentage of your portfolio companies which have undertaken a dividend recap in the last three years have resulted in higher leverage (net debt to EBITDA) immediately after

the recap as compared to immediately after the original investment?

Debt to EBITDA multiple increases

Debt to EBITDA multiple is unchanged

Debt to EBITDA multiple decreases

31%

25%

31%

13%

What is in your opinion the major hurdle when doing a dividend recap?

Potential loss of covenant headroom

Opposition by the portfolio firm management

Getting access to debt capital

Negative impact on money multiple on investment


factors which allow for higher debt levels without paying higher interest rates. Less

measurable but still somewhat important are improvements in growth prospects. Only of

little importance is an increase in tangible assets or revenues. As far as senior debt is con-

cerned, over 80 percent of private equity funds in our survey look for clauses to control

debt transfers at least in some cases. One crucial hurdle seems to be banks, since a majori-

ty in our survey state that banks do not always agree on such terms.

Figure 12: Debt characteristics

For our survey participants, contract terms directly transfer into monetary values. This

can be concluded by the fact that almost half of our sample would pay more than 100 bps

61%11%

17%

11%

Which of the following covenants were most frequently breached?

Debt to EBITDAEBITDA to interest expenseCash flow to debt serviceCAPEX related rule

55%27%

18%

In your personal opinion, what is the increase in the interest rate you

would accept for replacing maintenance covenants with

incurrence (bond-style) covenants?

Up to 100 bps Up to 200 bps

More than 200 bps

17%

8%

58%

17%

As far as senior debt is concerned, do you seek clauses allowing you to

control transfers of this debt?

Yes, in all cases

Yes, but only if non-banks are in the syndicate

Yes, we try but banks do not always agree

No

38%

22%

28%

3%9%

In your opinion, which of the following factors allow for higher amounts of debt being available

without paying a higher interest rate?

Increasing cash flows from operational activitiesImproving growth prospectsImproving profitabilityHigher tangibility (i.e. size of tangible assets)Increasing revenues


for replacing maintenance covenants with incurrence covenants. When looking at cove-

nants which are most frequently breached, more than 60 percent mention debt to EBITDA

rules. Other covenants seem to be of only minor importance.

F. External drivers of debt financing

Evidently, debt markets in general and, more specifically, debt arrangements, play an

important role in the financing decisions of private equity firms. It is interesting to note in

this regard that even though we have seen some increase in the leverage of buyout trans-

actions the development of the debt markets is nevertheless seen as unfavorable by the

private equity firms.

First of all, more than 90 percent of the respondents are convinced that borrowing costs

today are not lower than they were in 2007. 61 percent of respondents think that these

costs are even higher as can be seen by Figure 13. This is striking, as the general interest

level today is by far lower than it used to be in 2007. However, while borrowing costs

have decreased for governments and large firms, the opposite may be true for smaller

firms with lower ratings.23 Moreover, the respondents unanimously agree that non-

financial hurdles today are much more important than they used to be before the financial

crisis. The track record of the financial sponsor as well as the quality of the relationship

between financial sponsor and lender especially impact on the probability of signing a

debt contract. A bit stunning is the fact that risk seems to be of minor importance as part

of non-financial hurdles. Neither risk management practices nor potential ancillary in-

come from borrowers seem to be very relevant.

23 Güntay and Hackbarth (2010) find a significant negative influence of better ratings and firm size on credit spreads.


Figure 13: Borrowing costs and non-financial hurdles

Another very important feature of borrowing contracts is how debt is redeemed. Two

popular options are regular amortization over the lifetime of the loan or a bullet repay-

ment at the end. Jenkinson and Stucke (2011) find a significant change in the conditions

of leveraged loan tranches. Before the financial crisis, the percentage of loans with bullet

repayment went up in their sample and simultaneously, regular amortization lost its

prevalence. As can be seen in Figure 14, this effect is reversed after the financial crisis.

Therefore, regular amortizations regained importance after 2008 while the median per-

centage of bullet repaid senior debt dropped from 45 percent in the period 2005-2007 to

33 percent in the last 24 months.

1

2

3

4

5

Rate the importance of the following non-financial hurdles with grades between 1 (totally unimportant) to 5 (very important)

1. Quartile

Median

3. Quartile

8%

31%

61%

In your opinion, how do the current overall borrowing costs compare to the situation in the year 2007?

Borrowing costs today are definitely lower

No significant difference

Borrowing costs today are definitely higher


Figure 14: Percentage of regular amortization debt

0%

25%

50%

75%

100%

2005-2007 2009-2011 Last 24 months

As far as senior debt is concerned, what percentage of the debt raised the mentioned period: Had to be repaid by regular amortizations?

1. Quartile

Median

3. Quartile


5. Outlook

Finally, survey participants have also been asked questions regarding their expectations

with respect to their market outlook, with special focus to future developments in Europe-

an mid-market buyouts. Of course, for the time being the general market outlook is favor-

able as M&A activity is increasing. In fact, Preqin reports an increase of almost 15 per-

cent in aggregated deal value for the first quarter of 2014 compared to the previous year´s

first quarter. Also the dry powder of private equity funds is currently higher than at the

end of 2013. Moreover, Preqin expects 32 fundraisings of European focused buyout funds

in the remaining of 2014.24 Moreover, as outlined in the institutional investor section of

Preqin (2014) the share of institutional investors being currently below their intended

exposure in private equity has increased from 28 percent to 39 percent over the last 12

months. Simultaneously, according to Preqin (2014) buyout funds and funds with a Euro-

pean focus are the most asked for by institutional investors with 78 percent and 95 per-

cent, respectively.

Turning to debt financing activities, Figure 15 shows our survey participants’ expecta-

tions for the upcoming two years. The dominant viewpoint suggests further rising debt

levels caused by the improvement in overall market conditions. For 20 percent of re-

sponses, a second trend, namely the substitution of bank financing with bonds, is ex-

pected to continue. Following our participants’ opinion, a drop in bank lending to private

equity funds or their respective target firms is rather unlikely over the next two years.

24 As of the beginning of May 2014.


Figure 15: Debt market outlook

Finally, as one of our focus areas was on recapitalizations, in our survey we asked about

the recent and planned recapitalization activities as illustrated in Figure 16. The partici-

pants plan to increase their dividend recaps by 50 percent compared to the actual actions

over the last 24 months. Using debt to finance new growth opportunities will continue to

be the major reason for recapitalizations, although an increase is not expected. Last but

not least, we anticipate a tremendous fall in recapitalizations to refinance existing debt.

Those recapitalizations seem to be irrelevant over our survey participants’ planning hori-

zon.

Figure 16: Recapitalization outlook

50%

5%10%

20%

15%

As far as your debt financing activities are concerned, which of the following do you expect to happen over the next 24 months?

Debt levels will further rise because of improving market conditionsBank lending to private equity companies will fall

Bank lending will fall for small and medium-sized private equity owned companiesBond financing will further gain importance as a substitute for bank financingPerformance pressure on private equity funds will result in increasing leverage

10%

24%

12%15%

25%

2%

… increasing their debt and repaying funds to the

shareholders (dividend recap)

...increasing their debt in order to finance new growth

opportunities

...increasing their debt in order to refinance existing debt

What percentage did you do a recapitalization by…?

Over the last 24 months You are planning to do it


6. Case Studies

A. Overview

Aside from our survey and data analyses focusing on mid-market buyouts in Europe, we

were able to obtain detailed information on selected transactions provided by the respec-

tive private equity firms. These case studies enable us to illustrate our previous conclu-

sions on individual transactions. All cases are European mid-market buyouts by private

equity firms with the strategic focus on growth financing. Table 2 gives an overview of

the following case studies.

Target firm Private equity firm Region Strategic approach Investment year

Elixia Norvestor Nordics Growth financing 2006

Teufel Riverside Germany Growth financing 2006

Visma HgCapital Norway Growth financing 2006

Table 2: Overview of case studies

B. Norvestor buys Elixia

Private equity firm: Founded in 1993, Norvestor Equity AS (“Norvestor”) is currently a

leading private equity company in Norway, which focuses on lower mid-market buyout

transactions. Typically, target firms are growth companies in the Nordics which have the

potential to become leaders in their respective industries. One essential component of

Norvestor’s strategy is identifying markets with underlying growth potential.

Value creation is driven by Norvestor’s support to become an industry leader through

organic growth or acquisitions. Additionally, the combination of financial skills with op-

erational improvements should help to generate long-term success for target firms. This

major focus of Norvestor relies on its experienced team with operative as well as private

equity backgrounds. Furthermore, the team has been working together since 1991 and has

executed over 50 investments with almost 200 bolt-on acquisitions and divestitures. As of

2014, Norvestor manages over 700 million Euro.


Target firm: In 2005, Elixia Nordic ASA (“Elixia”) operated 21 fitness and wellness

clubs in Norway and Finland with a turnover of over 40 million Euro. The company’s

strategy was to provide a broad range of fitness services – such as strength training, car-

dio, and different types of classes – in modern clubs to people of all ages. What differen-

tiates Elixia from other fitness companies is its focus on the upper segment by employing

professional staff and providing high-quality equipment. As a result, Elixia was leading

the market in customer satisfaction. This is also underlined by Elixia’s vision of “Keep

Members for Life”.

Transaction procedure: The private equity firm Compass Advisers, the former owner of

Elixia, ran a dual-track process. After a failed IPO, Norvestor bought Elixia’s operations

in Norway and Finland in August 2006, considering this part of Elixia as financially

sound. Elixia held number two positions in those markets at that time. Norvestor’s goal

was to focus on growth as value driver. This is in line with what Elixia expected from

Norvestor: focus on growth with local resources to support the firm in rolling out new

fitness clubs and financial capabilities for acquiring competitors. Before buying a majori-

ty stake in Elixia, Norvestor was in negotiation with another local fitness company which

later became a bolt-on acquisition to Elixia.

In addition to the bidding process introduced by the previous owner, this transaction had

at least three more features which are typical for private equity investments: the leveraged

buyout characteristic, a significant stake invested by the management team as well as by

other key employees, and two limited partners investing in Elixia. The final enterprise

transaction value was 83 million Euro, with an enterprise value to EBITDA of 8.3 and a

debt to EBITDA multiple of 5.0.

Debt specification: As typical of a leveraged buyout transaction, Norvestor used a signifi-

cant amount of debt to finance their 83 million Euro takeover of Elixia. The implemented


leverage ratio was primarily determined by the debt capacity of Elixia. After the initial

debt financing, follow-up debt was raised to fund a significant bolt-on acquisition. In both

instances, the lending bank was DNB Bank ASA. Although there were no non-financial

hurdles in place, two different covenants were implemented. First, net interest-bearing

debt to EBITDA started at 5.0 and phased out at 2.5 after 2.5 years. Second, EBITDA to

gross financing costs started at 3.1 and phased out at 6.2 after 2.5 years. The implemented

debt with a maturity of 5 years was a combination of regular amortization and bullet re-

payment. The senior debt was refinanced in five steps during Norvestor’s ownership of

Elixia.

Strategic approach: Norvestor viewed Elixia as an opportunity to participate in an indus-

try with attractive growth potential. In 2006, the private equity firm believed that the

Nordic fitness market was underdeveloped and that in the following years more people

would commit themselves to exercise, resulting in an increased number of memberships.

Besides a boost in memberships, Norvestor expected value creation by rolling out new

fitness clubs, completing bolt-on acquisitions, and increasing the average revenue per

member and month, i.e. the so called yield. Norvestor’s choosing of Elixia was by no

means accidental; the latter’s characteristics – commercially-oriented management, highly

satisfied customers, and being the leader in offering group classes – were visibly valuable.

Corporate development: Even though Elixia was a sound company with consistent rapid

growth, there was still room for improvement. Norvestor focused on increasing net mem-

ber gains25, yield, and secondary income. Increasing the latter was primarily through per-

sonal training, which resulted in an increase in risk diversification for the target company.

Table 3 shows several key figures before Norvestor bought its majority stake in 2006 and

before Norvestor exited Elixia in 2011. Membership almost doubled from 86.000 to

25 New members minus terminated ones.


170.000. The number of fitness clubs doubled from 23 to 46. At the same time, Elixia

increased its yield from 50 Euro to 62 Euro, mostly through the sale of personal training

sessions. Since Elixia was positioned in the upper class of fitness clubs, high customer

satisfaction was crucial for its success. The decreasing churn rate of 41 percent to 37 per-

cent serves as minor evidence of no loss in quality. With growth as the main value driver,

several bolt-on acquisitions were made. A significant step into new markets – namely

entering the Swedish market for fitness clubs – was achieved through the acquisition of

two fitness clubs in Gothenburg in 2010. During the investment horizon of Norvestor, no

material changes to the management team were executed.

Before acquisition Before exit

Group EBITDA margin 18.5% Group EBITDA margin 23.5%

Revenue 50 m€ Revenue 115 m€

EBITDA 9.3 m€ EBITDA 26.6 m€

Position in home market 2 Position in home market 1

Members 86.000 Members 170.000

Fitness clubs 23 Fitness clubs 4626

Churn rate 41% Churn rate 37%

Yield 50 € Yield 62 €

Table 3: Key figures of Elixia during Norvestor’s investment period

Exit: In May 2011, Norvestor sold Elixia to the private equity fund Altor III L.P., realiz-

ing an IRR of approximately 52 percent. This IRR is higher than the originally planned

one due to faster growth and higher-than-expected profitability. Furthermore, the IRR was

increased by primarily funding the bolt-on acquisitions with debt. The exit was executed

as a structured auction process and timed when Norvestor exceeded its return require-

ments. In retrospect, this was perfect timing, considering the strong bank financing mar-

ket at the moment, which shortly deteriorated in 2011. The financial crisis hardly affected

26 With seven signed lease contracts for new fitness clubs.


this leveraged buyout since the geographical footprint of Elixia was only slightly influ-

enced.

Without doubt key financials of Elixia improved during the ownership by Norvestor. The

EBITDA margin increased by 5 percentage points to 23.5 percent and at the same time

both the revenue and the EBITDA more than doubled. During the 5 year investment peri-

od, Elixia went from holding number two positions in Norway and Finland to holding

number one positions in both markets. For Norway, Elixia’s market share before Nor-

vestor’s exit was around 22 percent. Additionally, Elixia was the most profitable fitness

club operator in the Nordics and managed to enter the Swedish market.

Elixia’s reliable and cash generative business model also allowed Norvestor to use divi-

dend recapitalizations in this leveraged buyout, as banks provided additional debt without

any major challenges. This new debt was used to distribute funds to shareholders before

the exit was finalized, which undoubtedly increased their return on investment.

C. Riverside buys Teufel

Private equity firm: As of 2014, The Riverside Company (“Riverside”) has more than 25

years and over 345 transactions of experience with a total enterprise value exceeding 7

billion Euro. This global private equity firm focuses on small- and mid-sized enterprises

in all industries, which have the potential of being leaders in their respective sectors. Typ-

ically, strong management teams will boost the target firm through acquisitions or organic

growth. Around 200 employees manage 3.3 billion Euro in assets, making Riverside one

of the leading global mid-market buyout firms. Riverside provides assistance in critical

areas (such as sales, marketing, pricing optimization, and sourcing) to its smaller target

firms, which would not have access to those services on their own.

Target firm: Founded in 1980, Lautsprecher Teufel GmbH (“Teufel”) is a German-based

designer and manufacturer of medium- to high-end audio devices. They offer a wide


range of products, including but not limited to home cinema loudspeaker systems, iPod

products, and accessories. Teufel differs from its competitors by its strong brand recogni-

tion and its focus on direct sales. This allows Teufel to control the full value chain and

have direct access to its customers. Furthermore, Teufel’s products have great value for

their price. At the end of 2005, Teufel was in economically sound conditions.

Transaction procedure: In the fall of 2006, the founder and previous owner of Teufel

decided to sell the company. Besides an attractive purchase offer, the founding family

expected the buyer to professionally develop their company. In October 2006, Riverside

won the full auction process and bought Teufel for an enterprise value of 36 million Euro,

resulting in an enterprise value to EBITDA multiple of 8.65. The founder later took on a

board role and reinvested into his former company.

Debt specification: Although it was a regular leveraged buyout, the seller provided a ven-

dor note apart from its significant reinvestment. Other than that, the used debt characteris-

tics were usual for leveraged buyouts. According to Riverside the debt to EBITDA multi-

ple was 4.9. Furthermore, the primary reason for raising debt was to increase the return on

equity. The appropriate transaction leverage was driven by both the bank’s willingness

and the target firm’s ability to pay down debt. Nord LB, a local bank, provided the initial

debt, with usual financial and information covenants. The maturity of this debt was 5 to 6

years. Repayment of this debt was a mix of regular amortization and bullet repayment.

Strategic approach: Riverside chose Teufel as target firm because of its clear profession-

alization and development potential. In particular, Riverside planned on modernizing its

sales and distribution channels by implementing an online sales model. This online sales

model would allow an internationalization of Teufel which was then solely focused on the

German market. By implementing this new distribution channel, Riverside expected top

line as well as EBITDA growth while improving Teufel’s cash generation capability.


Corporate development: To generate value, Riverside implemented several operational

changes. Teufel’s culture, which had up to this point been hierarchal, started becoming

more team-oriented in the hope of empowering employees. The company also replaced its

entire management team. Since the former owner and head of Teufel wanted to step away

from day-to-day operations, a new chief executive officer with extensive experience in

online retailing was shortly installed by Riverside. Within the first year of Riverside’s

investment, the rest of the board was also filled with industry experts. The expectation

was that the newly formed board could contribute to business development and share ex-

periences and networks in order to grow Teufel. In addition, Riverside used its broad

network of partners and provided external international experts to the target firm.

One main aspect was to professionalize all aspects of online marketing, which led to a

1:15 ratio of money invested to incremental revenues. A factor in this progress was the

development of a new website designed to enhance sales while improving user experience

and helping transition Teufel into e-commerce. A new ERP system was also implement-

ed, which allowed for additional optimization possibilities and secure operational stabil-

ity.

Riverside’s goal of expansion was achieved through organic growth instead of bolt-on

acquisitions. Therefore, existing product lines were extended into integrated systems, and

Teufel entered into other European markets. Guided by Riverside, the new systems be-

came bestsellers in a mere few months, almost instantly generating strong sales. A dozen

of Teufel’s technicians focused on new trends and on developing new products. The lat-

ter’s success can be seen in the number of introduced products – 8 in 2008, 14 in 2009,

and 20 in 2010.

Teufel’s continued strength of high quality products kept customer satisfaction very high

and ensured that the outbreak of the financial crisis hardly influenced the corporate devel-


opment. On one hand, this can be seen in compound annual growth rates over Riverside’s

investment period for revenues and EBITDA of 28 percent and 29 percent, respectively.


Revenue 16.5 m€ Revenue 41.4 m€

EBITDA 4.2 m€ EBITDA 11.0 m€

Gross margin 55.1% Gross margin 59.3%

EBITDA margin 25.0% EBITDA margin 26.4%

Employees 26 Employees 72

Table 4: Key figures of Teufel during Riverside’s investment period

Table 4 provides further evidence for the rapid rise of Teufel. By working with the man-

agement and committing to expand the company, Riverside almost tripled the number of

employees while more than doubling revenues and earnings during its ownership period.

At the same time, Riverside was able to increase Teufel’s already high margins. The gross

margin improved by 4.2 percent to 59.3 percent, whereas the EBITDA margin was in-

creased by 1.4 percent to 26.4 percent.

Exit: Since Riverside had not used dividend recapitalizations during its four year invest-

ment period, all the pressure was on its final exit. In July 2010, Riverside successfully

sold Teufel to the private equity company HgCapital, realizing a gross IRR of 61.5 per-

cent and a gross cash-on-cash multiple of 6.4.

This transaction marks one of the most successful investments in Riverside’s history and

simultaneously highlights the bright side of growth-oriented private equity investments.

According to the company itself Teufel today is the leader in direct speaker sales in Eu-

rope and offering the largest selection of THX loudspeakers worldwide.

D. HgCapital buys Visma

Private equity firm: In December 2000, the former private equity section of Mercury As-

set Management became an independent company named HgCapital LLC (“HgCapital”).


Based in the United Kingdom, the fund focuses on mid-market buyouts of European

companies with massive growth potential. HgCapital prefers innovative businesses in

markets with high barriers or with low customer churn rates which can become leaders in

their industries. To create value, this private equity firm supports the management of the

target company with expert knowledge in the respective sector. As of 2005, HgCapital

managed 37 portfolio investments and had previous experience in the software industry

with recent investments in Iris Software, Addison Software, PBSG, and Rolfe & Nolan.

In 2014, 100 employees worked for HgCapital and managed over 6 billion Euro.

Target firm: In 1996, a merger of Multisoft, SpecTec, and Dovre Informasjonssystemer

formed the Norwegian company Visma ASA (“Visma”). The publicly-listed firm offered

a variety of software solutions including traditional ERP modules (accounting, payroll

management, inventory management, among others) as well as new modules (CRM, HR,

among others) to small- and medium-sized enterprises. Only 10 years after its launch, the

company served over 200,000 customers and had 70 offices throughout Northern Europe,

giving Visma a leading market position.

Since the software segment in which Visma was operating was highly fragmented, growth

rates of 20 percent were possible. A significant part of this growth was realized through

acquisitions. Furthermore, Visma’s software was integrated in customers’ IT, allowing a

very low average churn rate of approximately 5 percent. Even though 50 bolt-on acquisi-

tions increased Visma’s market capitalization to around 400 million Euro in early 2006,

the EBITDA margin of 14 percent was behind that of its peers.

Transaction procedure: In spring 2006, Sage Group PLC – one of the leading providers

in accounting and business management software worldwide – initiated an acquisition of

Visma for around 500 million Euro. Sage Group PLC was a much larger rival with over

10,000 employees and 4.7 million customers. Since its presence was lacking in the Nor-


dics, Sage Group PLC wanted to enter into this new geographical market with an acquisi-

tion of Visma.

HgCapital worked closely with Visma’s management to prepare a counter-bid with the

goal of taking Visma private. In May 2006, HgCapital acquired Visma in a public-to-

private transaction for 550 million Euro. Several critical voices within HgCapital were

raised during the bidding process. Those were concerned with the firm’s lack of experi-

ence in this geographical region, the uncertainty of possible improvements, and the deal

size.

Debt specification: Since the leveraged buyout was a counter-bid to the offer of Sage

Group PLC, it was crucial to raise the necessary amount of debt as quickly and confiden-

tially as possible. HgCapital had to make the decision whether to borrow from a Nordic

bank, which would give it the advantage of a likely larger loan at low interest rates, or to

borrow from a London-based bank, which would give it the advantage of speed and con-

fidentiality; it opted for the latter, choosing Citigroup as the lending bank for this transac-

tion.

The total transaction value of 550 million Euro was financed roughly two-thirds with

loans. A little over half the loans was considered senior debt, out of which 75 percent had

a bullet repayment with a maturity of 8 to 9 years and 25 percent had regular amortization

with a maturity of 7 years. To maintain Visma’s flexibility for additional acquisitions,

HgCapital had an undrawn revolver of around 25 million Euro and an undrawn acquisi-

tion facility of around 63 million Euro.

Strategic approach: Because of its subscription payment model, Visma had highly pre-

dictable recurring revenues. Nevertheless, HgCapital focused on improving this perfor-

mance as well as Visma’s profit margins which were, as aforementioned, below the mar-

gins of its peers. The performance improvement was planned to be accomplished by or-


ganic and acquisition-driven revenue growth. For the profit margins, HgCapital felt that

Visma was misunderstood by investors and analysts. High research and development in-

vestments as well as several recent acquisitions could explain the low profit margins.

Corporate development: HgCapital’s main focus was on further growing Visma’s busi-

ness. During the investment period, Visma completed more than 25 bolt-on acquisitions

and had an average organic growth in revenues of 10 percent, leading to an average total

growth of 16 percent a year. One major bolt-on acquisition was undertaken in 2007 when

HgCapital bought AccountView, a Dutch accountancy software company.

Visma’s business model and its performance proved robust through the financial crisis,

with an almost unchanged growth in revenues and EBITDA in 2009. Altogether, Visma’s

EBITDA grew from 40 million Euro to over 100 million Euro in just four years as shown

in Table 5. Simultaneously, HgCapital was able to realize a 6 percent improvement of the

EBITDA margin while attracting 20 percent new customers. The growth strategy also

generated 1,700 new jobs at Visma, boosting the employment to 4,200.


EBITDA 40 m€ EBITDA 104 m€

EBITDA margin 14% EBITDA margin 20%

Employees 2,512 Employees 4,200

Customers 200,000 Customers 240,000

Table 5: Key figures of Visma during HgCapital’s investment period

In addition to a major increase in revenues, EBITDA, and margins, HgCapital supported

Visma’s management in operating issues. The implementation of cross-selling and trans-

ferring one-time revenues into recurring ones helped enhance future cash flows. Further-

more, net promoter score programs, investments in the salesforce, and fixed pricing strat-

egies boosted customer satisfaction. Last but not least, Visma invested in cloud-based

technologies and increased its research and development investments.


Exit: In September 2010, HgCapital partially exited and sold a 64 percent stake in Visma

to the private equity firm KKR. This transaction valued Visma at approximately 1.4 bil-

lion Euro and led to a preliminary IRR of 37 percent. HgCapital retained a significant

stake in Visma to benefit from the company’s further potential growth. The preliminary

investment multiple is 3.7. Finally, HgCapital sold its remaining stake in April 2014, real-

izing a total gross IRR of 34 percent. The final outcome of this leveraged buyout was not

only a tremendously successful investment for HgCapital, but also the placing of Visma

as one of the top software and service firms in Europe.


7. Appendix EVCA survey Q1: In which country is your head office located? Q2: How many employees (FTE) does your private equity firm have? Q3: What is the committed capital of the latest fund you have raised (in € millions)? Q4: What is the primary focus of your private equity firm (please tick all that apply)? Answer choices: a. Lower mid-market transactions (50-100 m€ by average transaction value); b. Core mid-market transactions (100-250 m€ by average transaction value); c. Upper mid-market transactions (250-500 m€ by average value) Q5: Do you have a regional focus or are you pan-European? Answer choices: a. Pan-European; b. Focused, and the most important countries are Q6: Do you have a sector focus? Answer choices: a. No focus; b. Yes, and the most important sectors are Q7: In how many different portfolio companies is your firm currently invested? Q8: Does your firm have at least one dedicated loan/debt market specialist and what is the rank of this person? Answer choices: a. Yes, and he/she is a senior member of the firm; b. Yes, and he/she is a junior member of the firm; c. No Q9: Have you ever set up or planned to set up a debt fund? Answer choices: a. Yes, we have set up a debt fund; b. Yes, we are planning to set up a debt fund; c. No Q10: Your transactions in the last 24 months: A) average enterprise value to EBITDA multiple; B) lowest enterprise value to EBITDA multiple; C) highest enterprise value to EBITDA multiple; D) average debt to EBITDA multiple; E) lowest debt to EBITDA mul-tiple; F) highest debt to EBITDA multiple; G) average ratio of senior debt to the enter-prise value; H) lowest ratio of senior debt to the enterprise value; I) highest ratio of senior debt to the enterprise value Q11: Your transactions between 2009-2011: A) average enterprise value to EBITDA mul-tiple; B) lowest enterprise value to EBITDA multiple; C) highest enterprise value to EBITDA multiple; D) average debt to EBITDA multiple; E) lowest debt to EBITDA mul-tiple; F) highest debt to EBITDA multiple; G) average ratio of senior debt to the enter-prise value; H) lowest ratio of senior debt to the enterprise value; I) highest ratio of senior debt to the enterprise value Q12: Your transactions between 2005-2007: A) average enterprise value to EBITDA mul-tiple; B) lowest enterprise value to EBITDA multiple; C) highest enterprise value to EBITDA multiple; D) average debt to EBITDA multiple; E) lowest debt to EBITDA mul-tiple; F) highest debt to EBITDA multiple; G) average ratio of senior debt to the enter-


prise value; H) lowest ratio of senior debt to the enterprise value; I) highest ratio of senior debt to the enterprise value Q13: As far as senior debt is concerned, what estimated average percentage of transac-tions involved some debt being sold in a syndication process by underwriters: A) For transactions completed over the last 24 months; B) For transactions completed over the period 2009-2011; C) For transactions completed over the period 2005-2007 Q14: For investments you have made with debt finance, what was the percentage of loans/bonds that contained one of the following covenants: A) Some combination or all of debt to EBITDA, EBITDA to interest, cash flow to debt service and capex limited; B) Asset-based maintenance covenants; C) Incurrence covenants only Q15: Which of the following covenants were most frequently breached? (Make up to two choices) Answer choices: a. debt to EBITDA; b. EBITDA to interest expense; c. Cash flow to debt service; d. Debt to equity; e. CAPEX related rule; f. Net working capital related rule Q16: In your personal opinion, what is the increase in the interest rate you would accept for replacing maintenance covenants with incurrence (bond-style) covenants? Answer choices: a. Up to 100 bps; b. Up to 200 bps; c. More than 200 bps Q17: As far as senior debt is concerned, have non-financial hurdles become more im-portant in the loan decision of banks since the financial crisis? If yes, please rate the fol-lowing examples with grades between 1 (totally unimportant) to 5 (very important) A) Country of the borrower; B) Size of the borrower; C) Sponsor track record or reputation; D) Existing lending relationship between lender and sponsor; E) Existing lending rela-tionship between lender and portfolio firm; F) Risk management practices of the borrow-er;G) Potential ancillary income from the borrower e.g. hedging, cash management Q18: As far as senior debt is concerned, do you seek clauses allowing you to control transfers of this debt? Answer choices: a. Yes, in all cases; b. Yes, but only if non-bankers are in the syndicate; c. Yes, we try but banks do not always agree; d. No Q19: As far as senior debt is concerned, what percentage of the debt raised over the last 24 months: A) Had to be repaid by regular amortizations; B) Had a bullet repayment Q20: As far as senior debt is concerned, what percentage of the debt raised in the period 2009-2011: A) Had to be repaid by regular amortizations; B) Had a bullet repayment Q21: As far as senior debt is concerned, what percentage of the debt raised in the period 2005-2007: A) Had to be repaid by regular amortizations; B) Had a bullet repayment Q22: In your opinion, how do the current overall borrowing costs compare to the situation in the year 2007? Answer choices: a. Borrowing costs today are definitely lower; b. No significant differ-ence; c. Borrowing costs today are definitely higher


Q23: As far as overall debt is concerned, which average percentage of this debt employed in your portfolio companies is repayable: A) Over the next 2 years; B) Over the next 5 years; C) In more than 5 years Q24: In the transactions that you have executed over the last 24 months, what percentage of the overall debt (pre-syndication) was provided by: A) Internationally active (large) banks; B) Regionally active (small and medium) banks; C) Debt funds; D) Issue of bonds; E) Others Q25: Comparing the transactions over the last 24 months with those that you have done before, which of the following is true? Answer choices: a. Loans have become more important as a financing source; b. Loans have become less important as a financing source; c. Bonds have become more important as a financing source; d. Bonds have become less important; e. Junior debt (incl. mezza-nine) has become more likely as a finance source; f. Junior debt (incl. mezzanine) has become less likely as a financing source; g. None of these Q26: In your opinion, have debt funds become a more important source of liquidity for your portfolio investments since the financial crisis? Answer choices: a. Yes; b. No; c. Unchanged Q27: At the point of making an investment, what are your primary reasons for raising debt? Please rate the following alternatives between 1 (totally unimportant) to 5 (very important) A) Economizing on tax advantages; B) Boosting the fund performance (lever-age effect); C) Realizing short term growth opportunities; D) Exerting pressure on the portfolio firm’s management; E) Increasing the fund’s diversification by reducing the equity stake in one single transaction; F) Being able to execute larger transactions Q28: At the point of making an investment, what is your typical approach to determining how much debt to raise for this acquisition? Please rate the following alternatives some-where between 1 (totally unimportant) to 5 (very important) A) Maximize undrawn facili-ties to preserve liquidity; B) Maximize senior debt and avoid subordinated debt; C) Max-imize debt; D) Minimize cost of debt; E) Maximize debt subject to your financial risk appetite; F) Simply driven by market opportunities Q29: What are your primary reasons for raising new debt after the original acquisition debt? Please rate the following alternatives somewhere between 1 (totally unimportant) to 5 (very important) A) Providing growth capital to the firm (e.g. capex); B) Providing li-quidity for ordinary course of business; C) Providing funds for bolt-on acquisitions; D) Providing earlier repayments to the shareholders (recapitalization); E) Benefiting from market opportunities (i.e. cheap debt, improved access to debt, etc.); F) Refinancing exist-ing debt Q30: According to your experience, what percentage of your portfolio companies which have been refinanced in the last three years have resulted in higher leverage (net debt to EBITDA) immediately after the refinancing as compared to immediately after the original investment? (Answer this questions based on the refinancing that you have done over the last 3 years) Q31: What are your primary reasons for refinancing existing debt with new loans? Please rate the following alternatives between 1 (totally unimportant) to 5 (very important) A)


Reduce cost of capital; B) Reset covenant levels; C) Change the lending group; D) Extent the repayment profile; E) Fund dividend payments to shareholders Q32: For what percentage of your current or former portfolio firms did you do a recapital-ization by increasing their debt and repaying funds to the shareholders (dividend recap)? A) Over the last 24 months; B) You are planning to do it Q33: For what percentage of your portfolio firms did you recapitalize by increasing their debt in order to finance new growth opportunities? A) Over the last 24 months; B) You are planning to do it Q34: For what percentage of your portfolio firms did you recapitalize by increasing their debt in order to refinance existing debt? A) Over the last 24 months; B) You are planning to do it Q35: What do you think is an appropriate time span between the completion of a buyout deal and a dividend recap? Answer choices: a. Not important; b. 12 months at least; c. 24 months at least; d. De-pends on the specific situation of the portfolio firm Q36: How important are dividend recaps as a part of your long-term realization strategy? Answer choices: a. Very important; b. Somewhat important; c. Not important Q37: According to your experience, has the willingness of debt holders to provide debt for dividend recaps increased over the past 24 months as compared to the situation be-fore? Answer choices: a. Yes; b. No; c. Unchanged Q38: If yes, for which of the following debt holders this is especially true? Answer choices: a. Internationally active (large) banks; b. Regionally active (small and medium) banks; c. Bondholders; d. Debt funds; e. All of these Q39: What percentage of your portfolio companies which have undertaken a dividend recap in the last three years have resulted in higher leverage (net debt to EBITDA) imme-diately after the recap as compared to immediately after the original investment? (Answer this questions based on the recaps that you have done over the last 3 years) Please assume that market conditions are unchanged. Answer choices: a. Debt to EBITDA multiple increases; b. Debt to EBITDA multiple is unchanged; c. Debt to EBITDA multiple decreases; d. I do not care about the debt to EBITDA multiple in this regard Q40: What are your primary objectives in a dividend recap? Answer choices: a. Maximize short-term payments to shareholders; b. Reduce portfolio firm’s cost of capital; c. Reduce fund exposure to portfolio firm; d. Maximize fund’s IRR Q41: What is in your opinion the major hurdle when doing a dividend recap? Answer choices: a. Potential loss of covenant headroom; b. Opposition by the portfolio firm management; c. Potential negative press news; d. Getting access to debt capital; e. Negative impact on money multiple on investment Q42: As far as your debt financing activities are concerned, which of the following do you expect to happen over the next 24 months?


Answer choices: a. Debt levels will further rise because of improving market conditions; b. Bank lending to private equity companies will fall; c. Bank lending will fall for small and medium-sized private equity owned companies; d. Bond financing will further gain importance as a substitute for bank financing; e. Performance pressure on PE-funds will result in increasing leverage Q43: In your opinion, which of the following factors allow for higher amounts of debt being available without paying a higher interest rate? Answer choices: a. Increasing cash flows from operational activities; b. Improving growth prospects; c. Improving profitability; d. Higher tangibility (i.e. size of tangible assets); e. Increasing revenues


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