Nowadays, these low multiples can no longer be realized. Too much capital chasing assets, low interest rates and the high public equity valuations led to an unprecedent rise in valuations. Buyout funds on average pay 12 times EBITDA for their investments. Still, lenders have not increased their appetite in providing more than three times EBITDA for the acquisition finance. Applying this equation to the LBO model, one can immediately see the impact on the return profiles. Ceteris paribus they would go down to multiples of 1.35 or IRRs of 6% p.a.
What does that mean for PE practitioners? The only answer to this situation is more focus on value creation within their assets. Simple financial engineering is not enough to meet the return expectations of LPs. Using the same example again, a fund would need to improve the EBITDA of the portfolio company by 5% p.a. to achieve the same return profile.
This completely alters the talent profile of an investment professional. Prior to the investment, a substantiated investment hypothesis needs to be developed with a clear path forward on how to create value in the portfolio company. What top-line measures can be realized; what bottom-line improvement can be achieved. What can be done? Who is needed? What are contingencies? How can it be monitored? Analytical thinking or Excel-skills become less relevant and/or more a hygiene factor. It is all about judgment, experience and execution.