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What stage of the business life cycle would a buyout fund purchase a company at i.e. Startup, Growth phase, Maturity or Decline?
The correct answer is in the maturity phase. Buyout funds borrow significant debt, sometime almost as high as 70% to 80% of the purchase price of the company. Servicing this mountain of debt is critical for the survival of the business. Only companies in the mature phase which are generating healthy operating cash flows and have minimal capex requirement have the financial muscles to service the debt. Additionally, mature companies also typically have significant fixed tangible assets that need to be pledged against the debt borrowed.
Growth companies are ruled out as they generally require high capex to fuel that growth which eats into the cash flows required to service the debt. Growth companies also trade on higher book value multiples which means the level of fixed tangible assets may not be enough to offer as a security for the debt raised.
Start-up companies are riskier and typically have negative cash flows, meaning taking on too much debt equates to signing a suicide note for the company.
Companies in decline phase generally see cash flows decelerating which can make for a twitchy lender. Having said that some Private Equity companies specialise in buying companies in decline or distress on the cheap and turning them around to make handsome returns.
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