Private Equity Finance: The Value of Approval

What men proverbially say about women also applies to private equity firms and credit providers. That is, you can’t live with ‘em and you can’t live without ‘em. With private equity financing, we are able to create the returns they’ve become accustomed to (we’re talking pre-crisis here). But without debt, private equiteers would also live an extra 10 years from not having the stress related to covenants and disapprovals.

Getting credit approval for an investee makes the deal much more likely since debt helps to achieve higher returns (if all goes well). But, there’s more value to credit approval than just private equity funding for the original deal:

Firstly, getting credit approval somewhat confirms your analysis and optimism around the deal. We all like to think we’re objective, but it’s good to get some confirmation from an independent team.
Secondly, if a bank is willing to extend financing now (especially post-crisis), then it’s safe to assume that the potential buyer of the investee in 3-7 years will also be able to get credit. Sure, there are a million and one variables, but it still gives some comfort around an easier exit or divestment.
Lastly, getting private equity financing approval now gives comfort around the likelihood of a recapitalization. You may know my view on recaps from previous posts (do a search if you’re interested), but alas, it’s still an exit option and needs thought. So knowing you can get 3 or 4 times EBITDA in debt now will give you some comfort around recapping out of the investment if all goes well.

So while it really is a love-hate relationship, there is an implicit need for more love than hate. Anyway, this post is about the hidden value in getting the tick of approval from private equity financing teams at banks, so I digress.
The real message in this post is that if you can’t get credit approval now, then maybe the deal isn’t the right deal. Current conditions have made debt harder to get, but at the same time, getting approval now may say something quite positive about your deal. Maybe you just don’t need to be doing those deals that are borderline with the banks. And, as I’ve discussed, private equity financing team disapproval has underlying consequences regarding divestment. Do you really want to be entering deals that may be hard to exit? The exit crystallizes the value you’ve created; the exit directly affects your return; the exit is the Holy Grail.