We referenced leveraged private equity investments in our post about institutional equity investors. This brief post gives a quick overview of how that leverage could look for a business owner.
When a PE firm makes an investment in a business, usually for majority positions, it may be all in cash; however, often the investment will come with leverage (debt). This debt can come in many forms. For simplicity, we will address just a couple types here.
One form of debt is a standard form of business debt, usually coming from one or more banks. If you read our post on debt options, this would be from traditional and non-traditional banks.
Another form of debt would come from mezzanine funds (which includes banks with a mezzanine division). You can learn more about mezzanine funds in our debt post, as well. Sometimes, the mezzanine debt comes with an interest rate generally ranging from 1-3% that is considered paid-in-kind (also referred to as PIK interest). When there is PIK interest involved, the PIK amount is added to the remaining principle balance, increasing the total balance to be paid over the life of the loan.
What is most important to understand is that when a PE firm leverages an investment, the burden for that debt is placed on the business, not the firm itself. The business owner, along with the PE firm, must ensure that cash flow will be sufficient to cover the debt load now imposed on the business.