LBO Model Questions and Answers
1. Can you explain how the Balance Sheet is adjusted in an LBO model? - ANS-First, the
Liabilities & Equities side is adjusted - the new debt is added on, and the
Shareholders' Equity is "wiped out" and replaced by however much equity the
private equity firm is contributing. On the Assets side, Cash is adjusted for any
cash used to finance the transaction, and then Goodwill & Other Intangibles are
used as a "plug" to make the Balance Sheet balance. Depending on the
transaction, there could be other effects as well - such as capitalized financing
fees added to the Assets side.
2. Do you need to project all 3 statements in an LBO model? Are there any shortcuts? -
ANS-Yes, there are shortcuts and you don't necessarily need to project all 3
statements. For example, you do not need to create a full Balance Sheet - bankers
sometimes skip this if they are in a rush. You do need some form of Income
Statement, something to track how the Debt balances change and some type of
Cash Flow Statement to show how much cash is available to repay debt. But a
full-blown Balance Sheet is not strictly required, because you can just make
assumptions on the Net Change in Working Capital rather than looking at each
item individually.
3. Give an example of a "real life" LBO - ANS-The most common example is taking out
a mortgage when you buy a house. Here's how the analogy works: •
Down Payment: Investor Equity in an LBO •
Mortgage: Debt in an LBO •
Mortgage Interest Payments: Debt Interest in an LBO •
Mortgage Repayments: Debt Principal Repayments in an LBO • Selling the House:
Selling the Company / Taking It Public in an LBO
4. How could a private equity firm boost its return in an LBO? - ANS-1. Lower the
Purchase Price in the model.
2. Raise the Exit Multiple / Exit Price.
3. Increase the Leverage (debt) used.
4. Increase the company's growth rate (organically or via acquisitions).
5. Increase margins by reducing expenses (cutting employees, consolidating
buildings, etc.). Note that these are all "theoretical" and refer to the model rather
than reality - in practice it's hard to actually implement these.
5. How do you pick purchase multiples and exit multiples in an LBO model? - ANS-The
same way you do it anywhere else: you look at what comparable companies are
trading at, and what multiples similar LBO transactions have had. As always, you
also show a range of purchase and exit multiples using sensitivity tables.
Sometimes you set purchase and exit multiples based on a specific IRR target that
you're trying to achieve - but this is just for valuation purposes if you're using an
LBO model to value the company.
1. Can you explain how the Balance Sheet is adjusted in an LBO model? - ANS-First, the
Liabilities & Equities side is adjusted - the new debt is added on, and the
Shareholders' Equity is "wiped out" and replaced by however much equity the
private equity firm is contributing. On the Assets side, Cash is adjusted for any
cash used to finance the transaction, and then Goodwill & Other Intangibles are
used as a "plug" to make the Balance Sheet balance. Depending on the
transaction, there could be other effects as well - such as capitalized financing
fees added to the Assets side.
2. Do you need to project all 3 statements in an LBO model? Are there any shortcuts? -
ANS-Yes, there are shortcuts and you don't necessarily need to project all 3
statements. For example, you do not need to create a full Balance Sheet - bankers
sometimes skip this if they are in a rush. You do need some form of Income
Statement, something to track how the Debt balances change and some type of
Cash Flow Statement to show how much cash is available to repay debt. But a
full-blown Balance Sheet is not strictly required, because you can just make
assumptions on the Net Change in Working Capital rather than looking at each
item individually.
3. Give an example of a "real life" LBO - ANS-The most common example is taking out
a mortgage when you buy a house. Here's how the analogy works: •
Down Payment: Investor Equity in an LBO •
Mortgage: Debt in an LBO •
Mortgage Interest Payments: Debt Interest in an LBO •
Mortgage Repayments: Debt Principal Repayments in an LBO • Selling the House:
Selling the Company / Taking It Public in an LBO
4. How could a private equity firm boost its return in an LBO? - ANS-1. Lower the
Purchase Price in the model.
2. Raise the Exit Multiple / Exit Price.
3. Increase the Leverage (debt) used.
4. Increase the company's growth rate (organically or via acquisitions).
5. Increase margins by reducing expenses (cutting employees, consolidating
buildings, etc.). Note that these are all "theoretical" and refer to the model rather
than reality - in practice it's hard to actually implement these.
5. How do you pick purchase multiples and exit multiples in an LBO model? - ANS-The
same way you do it anywhere else: you look at what comparable companies are
trading at, and what multiples similar LBO transactions have had. As always, you
also show a range of purchase and exit multiples using sensitivity tables.
Sometimes you set purchase and exit multiples based on a specific IRR target that
you're trying to achieve - but this is just for valuation purposes if you're using an
LBO model to value the company.
