(Charlotte, NC – May 1, 2018)
In this six-part newsletter series, we highlight key practices that private equity investors put in place during the M&A process and address ways in which strategic buyers can borrow and/or adapt these practices to create value through acquisitions. This week we will look at the third key practice: use of leverage and cash flow.
Leverage is a core tenet of the Private Equity (“PE”) business model. Before making any acquisition, a PE determines how much debt it can draw to fund the transaction. Maximizing leverage at the lowest possible cost of capital in turn maximizes equity returns.
While PE firms look to maximize debt, they must also ensure they have adequate cash flow to service the debt. As a result, PE firms place significant emphasis on developing precise cash flow forecasts during the diligence process. Post close, firms heavily incentivize management to operate in a lean and efficient manner – streamlining expenses and working capital, – conduct periodic financial and performance reviews, and utilize the tax code to their advantage to maximize cash flows (e.g. lease vs. buy). Strategic buyers can adopt these best practices to develop detailed cash flow forecasts and also to incentivize management in such a way that incentives align with both broader organizational goals and cash flow generation.
While strategic buyers may not desire to extend leverage multiples as high as PE firms, they should practice disciplined cash flow management post close. Corporate buyers then have the flexibility to use those increased cash flows in any manner most beneficial to them, whether funding additional M&A, issuing dividends, buying back stock, or making capital improvements. Additionally, consistently higher free cash flow should directly increase the company’s value.
“North Inlet Advisors, LLC” provides financial advice to companies on capital formation, mergers, acquisitions, divestitures, restructurings, and other complex corporate transactions. North Inlet Advisors is not a retail broker-dealer, does not conduct underwriting activities, provide research, analyst reports, or solicit or carry accounts, or offer or sell securities products to retail customers. North Inlet Advisors is registered as a broker-dealer with the U.S. Securities and Exchange Commission (“SEC”) and is a member of the Financial Industry Regulatory Authority (“FINRA”) and Securities Investor Protection Corporation (“SIPC”). Please visit www.finra.org and www.sipc.org, or North Inlet’s regulatory webpage for more information.