Mergers and Acquisitions Final Exam
Questions and Solutions
On average leveraged buyouts perform ✅Well
Debt can reduce agency conflicts by ✅providing managers an incentive to work hard.
-no ability to pursue things that can benefit themselves. Have to work hard to meet
interest payments
LBO participants ✅-financial sponsors
-investment banks
-bank and institutional lenders
-bond investors
-target management
Financial sponsors include ✅-private equity funds
-hedge funds
-venture capitalist firms
Financial sponsors funding ✅-raise money from entities (insurance funds etc) and
wealthy individuals
-funds structured as limited partnerships
-funds vary in size, focus, and investment strategy
-perform due diligence on target
investment banks ✅-perform due diligence and credit analysis on target
-advise sponsor on best financing structure
-provide financing commitment (underwriter)
Investment banks do not plan ✅to hold all of the debt in deal
Bank and institutional lenders ✅-perform due diligence and credit anlaysis of the
target, or may just rely on the due diligence and credit analysis of the "lead" arrangers
(lead investment bank)
-want protective covenants and possible collateral in return for lending money
-attend "bank meeting" and get a "bank book" (CIM)
Bond investors ✅-high yield mutual funds
-bonds with a high yield to maturity meaning they are overall riskier
-attend a roadshow presentation
-receive an offer memorandum (OM)
, Offer memorandum ✅legal document that outlines details of the bond (same as the
CIM and the bank book except in bond context)
Target management ✅-most cases want to keep management if they are quality
-team is perhaps the most important marketers of the firm
-want to remain invested in the firm to align incentives
Strong LBO candidate characteristics ✅-strong and predictable cash flows
-strong market positions (high barriers to entry)
-strong opportunities to enhance efficiency
-strong growth opportunities
-low CAPEX requirements (low maintenance CAPEX)
-strong asset bases (more liquid assets)
-strong management teams
Tangible vs. intangible assets considering collateral ✅tangible better for collateral
(easier to estimate)
Maintenance CAPEX ✅necessary for firm and will impact future cashflows if
decreased.
-ex getting computer replaced every 3 years
Growth CAPEX ✅is discretionary
LBO time frame window ✅5 years
How to measure returns for LBO's ✅IRR
-cash return (what you are getting out, versus what you are putting in)
Primary exit/Monetization strategies ✅-sell it (to a strategic buyer preferably who can
have synergies)
-take it public
-recapitalize the firm (take on more debt)
-distressed debt repurchases
Financing structure of LBO's ✅-risk is compacted by dollar amount of debt, proportion
of debt, and type of debt (secured vs. unsecured)
-thinking about default risk
Secured debt ✅has collateral pledged with it while unsecured does not
Security ✅collateral/lien
seniority ✅contractual (within the bond contract specified, subordinated provisions)
Questions and Solutions
On average leveraged buyouts perform ✅Well
Debt can reduce agency conflicts by ✅providing managers an incentive to work hard.
-no ability to pursue things that can benefit themselves. Have to work hard to meet
interest payments
LBO participants ✅-financial sponsors
-investment banks
-bank and institutional lenders
-bond investors
-target management
Financial sponsors include ✅-private equity funds
-hedge funds
-venture capitalist firms
Financial sponsors funding ✅-raise money from entities (insurance funds etc) and
wealthy individuals
-funds structured as limited partnerships
-funds vary in size, focus, and investment strategy
-perform due diligence on target
investment banks ✅-perform due diligence and credit analysis on target
-advise sponsor on best financing structure
-provide financing commitment (underwriter)
Investment banks do not plan ✅to hold all of the debt in deal
Bank and institutional lenders ✅-perform due diligence and credit anlaysis of the
target, or may just rely on the due diligence and credit analysis of the "lead" arrangers
(lead investment bank)
-want protective covenants and possible collateral in return for lending money
-attend "bank meeting" and get a "bank book" (CIM)
Bond investors ✅-high yield mutual funds
-bonds with a high yield to maturity meaning they are overall riskier
-attend a roadshow presentation
-receive an offer memorandum (OM)
, Offer memorandum ✅legal document that outlines details of the bond (same as the
CIM and the bank book except in bond context)
Target management ✅-most cases want to keep management if they are quality
-team is perhaps the most important marketers of the firm
-want to remain invested in the firm to align incentives
Strong LBO candidate characteristics ✅-strong and predictable cash flows
-strong market positions (high barriers to entry)
-strong opportunities to enhance efficiency
-strong growth opportunities
-low CAPEX requirements (low maintenance CAPEX)
-strong asset bases (more liquid assets)
-strong management teams
Tangible vs. intangible assets considering collateral ✅tangible better for collateral
(easier to estimate)
Maintenance CAPEX ✅necessary for firm and will impact future cashflows if
decreased.
-ex getting computer replaced every 3 years
Growth CAPEX ✅is discretionary
LBO time frame window ✅5 years
How to measure returns for LBO's ✅IRR
-cash return (what you are getting out, versus what you are putting in)
Primary exit/Monetization strategies ✅-sell it (to a strategic buyer preferably who can
have synergies)
-take it public
-recapitalize the firm (take on more debt)
-distressed debt repurchases
Financing structure of LBO's ✅-risk is compacted by dollar amount of debt, proportion
of debt, and type of debt (secured vs. unsecured)
-thinking about default risk
Secured debt ✅has collateral pledged with it while unsecured does not
Security ✅collateral/lien
seniority ✅contractual (within the bond contract specified, subordinated provisions)
