Leveraged buyouts start to run into trouble

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The economics of highly leveraged private equity buyouts has again come under the spotlight after the owners of the Scottish telecoms company Damovo and the Little Chef roadside restaurant chain ran into trouble.

Venture capital firms are expected to invest $32bn (£16.4bn) in companies across the world this year, according to the consultancy Ernst & Young. It is the highest level of investment since the dotcom bubble burst in 2001, but concerns have emerged that businesses have been loaded up with too much debt.

Such concerns have been heightened by developments at Damovo. Apax Partners, the private-equity company, bought the Scottish telecoms business in 2001 for £327m but has been forced to hand over its stake to creditors after Damovo missed a deadline for interest payments. The highly geared business completed a debt refinancing last year but has suffered as a result of late payments from some of its large customers.

Meanwhile, the owners of the Little Chef chain have entered into talks to attract new investors after running into financial difficulties. Lawrence Wosskow and Simon Heath paid £52m to buy the business from the private equity company Permira in October 2005. The catering entrepreneurs then sold the restaurant chain's freehold property for £59m to fund the deal. and Mr Wosskow immediately tried to buy the Moto service station business. The Moto deal fell through and results at Little Chef have suffered due to rising rents on the property it sold.

The budget supermarket chain Kwik Save has also hit financial problems after asking its former parent Somerfield to waive around £20m of debt so that it can raise new funds.

Standard & Poor's expects credit defaults to gradually rise in 2007 as a result of higher debt and more onerous interest payments. "A growing number of leveraged buyouts have breached covenants in 2006, forcing bankers to either waive them or restructure the debt package. More such problems are inevitable in 2007," S&P said in a report.