• Fierce competition, historically cheap debt and stunning amounts of dry powder have driven buyout multiples to record highs.
  • Funds must thus deploy capital despite risk, or even probability, of contracting multiples in coming years.
  • As such, sponsors will continuously increase reliance on management teams to organically "discount the purchase multiple" and inorganically "blend the purchase multiple" to ensure strong returns.
  • In this Q&A, Rob Huxtable, Partner at Falcon, provides an inside look at the way sponsors think about platform multiples and growth.

The deal-making climate is producing unprecedented purchase multiples. How does that reality impact portfolio company operators?

We are at a historic high for multiples and a historic low for interest rates. Cheaper debt allows a fund to push more leverage onto a deal and pay a higher purchase price with less equity. But buying a company in that environment puts the sponsor at risk of paying a super premium for the asset if multiples contract over time.

Funds are aware of this dynamic which is why they aggressively focus on two things: 1.) Discounting their purchase price by accelerating the portfolio company’s rate of organic growth 2.) Inorganically lowering the blended entry multiple.

Some portfolio company CEOs and CFOs wonder why their private equity sponsor is hyper-focused on growth. It’s because they must often pay a premium EBITDA multiple in order to acquire the business. A higher purchase price multiple often makes an already high-pressure operating environment even more intense for C-Suite leaders.

Are funds transparent with operators about these pain points?

While we don’t believe sponsors intentionally avoid the topic, many miss the opportunity to proactively educate their management teams on these important deal mechanics. We often hear investors complain about management teams – “I wish my operators thought and acted more like investors.” This critique represents an opportunity for funds to bring their operators up the learning curve. Both sponsors and operators would benefit from engaging in these conversations.

How do sponsors use M&A to mitigate entry point risk?

Multiple arbitrage is a key lever...