Is Debt a Good or Bad Thing in Private Equity Deals?

Why the Use of Debt in Private Equity Transactions Often Raises Questions

When a private equity deal involves third-party debt, it can sometimes cause concern among vendors. The instinctive reaction is that the investor is “borrowing money to buy my business,” which feels like a negative.

In reality, the impact of debt depends entirely on the context of the transaction. If a vendor is selling 100% of their shares and exiting the business, the source of funding makes little difference. Once the deal completes, it no longer affects them.

However, when a vendor rolls over part of their proceeds to retain a stake in the business, the funding structure becomes far more important. In these cases, debt can work to their advantage.

How Debt Can Actually Benefit Vendors

By using third-party debt, a private equity fund reduces the amount of its own equity invested in the transaction. This change in funding mix can increase the vendor’s shareholding in the new structure, even if they roll over the same amount of value.

Consider a simple example:

• The business is valued at £15 million.

• The vendor rolls over £5 million.

• The private equity investor provides £10 million of equity and owns two-thirds of the business.

Now introduce £5 million of third-party debt.

• The investor contributes £5 million of equity.

• The vendor still rolls £5 million.

• The equity is now split 50:50.

The vendor receives the same cash on completion, but retains a much greater proportion of the equity going forward.

Balancing Risk and Reward

While leverage can enhance returns, it also introduces risk. Higher debt levels mean greater financial pressure and less flexibility if performance dips or capital investment is required.

The key lies in balance. A modest level of leverage can align incentives, improve returns for both sides, and preserve more equity for the vendor, provided the business has stable cash flows and a credible growth plan.

Why Structure Matters

Not all debt is equal. Terms around repayment, covenants, and security can all influence how comfortable a vendor should feel with the proposed structure. The same applies to the equity instruments being issued - the true economic ownership may differ if preference shares or ratchets are in play.

Understanding these nuances is vital to ensure that the retained equity genuinely reflects value and that the risk profile remains acceptable.

The Takeaway

Debt is not automatically a bad thing in private equity deals. Used sensibly, it can be a powerful tool that benefits both parties, lowering the investor’s capital outlay while increasing the vendor’s retained share and potential upside.

For vendors rolling value, it pays to look closely at the debt-equity mix and to take independent advice on the implications.

If you are exploring private equity investment in your healthcare business and want to understand how debt could affect your deal, we are always happy to share a view.