LBO Modeling Exam from Wall Street Prep –
What is the biggest difference between an LBO and an M&A? - Unlike an M&A, we're not assuming the
PE firm will keep the company long term
What makes a good LBO candidate? - -opportunity to cut costs
-stable cash flows
-good base of assets
-undervalued/low-risk
Walk me through a basic LBO model. - 1. Make assumptions about the Purchase Price and how much
debt to use
2. Create a Financial Sources & Uses section
3. Adjust the company's Balance Sheet
4. Project the company's statements and determine how much debt you can pay off each year
5. Calculate the IRR and an EBITDA exit multiple
,Why do you focus on Equity value in an LBO? - You need to acquire all the outstanding shares of a public
company
What is Bank Debt vs. High-Yield Debt? - -Bank debt (Revolver, Term Loan A/B): Lower, floating interest
rates, annual principal repayments, *maintenance* covenants (i.e. Total Debt/EBITDA must be below
4x), secured (collatoralized), allows prepayment
-High-yield debt (Senior/Subordinate notes, Mezzanine): Higher, fixed interest rates, no annual
repayments, *incurrence* covenants (i.e. the company can't acquire another and sell off assets), not
secured, doesn't allow prepayment
Why might a PE firm prefer High-Yield Debt? - -Don't want the risk of *floating* rates
-Intend to *refinance* the debt
-Aren't planning big expansions
-Don't believe their returns are sensitive to interest payments
How to assess the amount of debt to use: - You can look at recent, similar LBOs and assess the terms, or
you can look at your company's Leverage Ratio or Interest Coverage ratio, to see how much debt it can
afford to take on.
Leverage Ratio = - Debt / EBITDA
Interest coverage ratio - EBITDA / Interest Expense
What are reasonable Leverage and Coverage Ratios? - Debt/EBITDA should rarely exceed 10x.
For Interest Coverage, you want a number where the company can pay for its interest without trouble,
but also not high enough where it can't afford more debt.
, Why is it better to reduce the amount of cash PE firms pay up front? - The returns go up because
reducing the amount of cash you pay up-front for an asset has a disproportionate effect on your
returns... since money today is worth more than money tomorrow.
Common Uses of Funding - -Buyout of oldco's equity
-Refinancing of oldco debt
-Transaction & Financing fees
Common Sources of Funding - -Excess cash
-Debt (term loans, notes, etc.)
-Preferred stock
-Management rollover
-Sponsor equity
Do you pay the Equity Value or Enterprise Value in an LBO? - -If you *refinance* existing debt, the price
will be closer to the Enterprise Value
-if you *assume* the debt, the purchase price will be closer to the Equity value
What happens if the PE firm pays off the debt? - The PE firm must *increase* the funds required to buy
the company, and the debt goes under the *uses* column (purchase price is closer to the EV)
What happens if the PE firm assumes (takes on) the debt? - It has no impact on the total funds it must
raise, and it goes on the balance sheet of the PE firm and listed under *both* sources and uses
(purchase price closer to the Equity Value)
How do you project how much debt you can pay off each year after projecting the Income Statement? -
1. Calculate the LBO FCF
2. Set mandatory debt repayments and use any leftover FCF to make optional payments
What are some factors to consider when determining how much debt can be paid off using FCF's? - -the
company's minimum cash balance
-if the debt can be paid off early
What is the biggest difference between an LBO and an M&A? - Unlike an M&A, we're not assuming the
PE firm will keep the company long term
What makes a good LBO candidate? - -opportunity to cut costs
-stable cash flows
-good base of assets
-undervalued/low-risk
Walk me through a basic LBO model. - 1. Make assumptions about the Purchase Price and how much
debt to use
2. Create a Financial Sources & Uses section
3. Adjust the company's Balance Sheet
4. Project the company's statements and determine how much debt you can pay off each year
5. Calculate the IRR and an EBITDA exit multiple
,Why do you focus on Equity value in an LBO? - You need to acquire all the outstanding shares of a public
company
What is Bank Debt vs. High-Yield Debt? - -Bank debt (Revolver, Term Loan A/B): Lower, floating interest
rates, annual principal repayments, *maintenance* covenants (i.e. Total Debt/EBITDA must be below
4x), secured (collatoralized), allows prepayment
-High-yield debt (Senior/Subordinate notes, Mezzanine): Higher, fixed interest rates, no annual
repayments, *incurrence* covenants (i.e. the company can't acquire another and sell off assets), not
secured, doesn't allow prepayment
Why might a PE firm prefer High-Yield Debt? - -Don't want the risk of *floating* rates
-Intend to *refinance* the debt
-Aren't planning big expansions
-Don't believe their returns are sensitive to interest payments
How to assess the amount of debt to use: - You can look at recent, similar LBOs and assess the terms, or
you can look at your company's Leverage Ratio or Interest Coverage ratio, to see how much debt it can
afford to take on.
Leverage Ratio = - Debt / EBITDA
Interest coverage ratio - EBITDA / Interest Expense
What are reasonable Leverage and Coverage Ratios? - Debt/EBITDA should rarely exceed 10x.
For Interest Coverage, you want a number where the company can pay for its interest without trouble,
but also not high enough where it can't afford more debt.
, Why is it better to reduce the amount of cash PE firms pay up front? - The returns go up because
reducing the amount of cash you pay up-front for an asset has a disproportionate effect on your
returns... since money today is worth more than money tomorrow.
Common Uses of Funding - -Buyout of oldco's equity
-Refinancing of oldco debt
-Transaction & Financing fees
Common Sources of Funding - -Excess cash
-Debt (term loans, notes, etc.)
-Preferred stock
-Management rollover
-Sponsor equity
Do you pay the Equity Value or Enterprise Value in an LBO? - -If you *refinance* existing debt, the price
will be closer to the Enterprise Value
-if you *assume* the debt, the purchase price will be closer to the Equity value
What happens if the PE firm pays off the debt? - The PE firm must *increase* the funds required to buy
the company, and the debt goes under the *uses* column (purchase price is closer to the EV)
What happens if the PE firm assumes (takes on) the debt? - It has no impact on the total funds it must
raise, and it goes on the balance sheet of the PE firm and listed under *both* sources and uses
(purchase price closer to the Equity Value)
How do you project how much debt you can pay off each year after projecting the Income Statement? -
1. Calculate the LBO FCF
2. Set mandatory debt repayments and use any leftover FCF to make optional payments
What are some factors to consider when determining how much debt can be paid off using FCF's? - -the
company's minimum cash balance
-if the debt can be paid off early
