Leveraged Buyouts and LBO Models
Questions and Answer
1. "Double your money" formula - ANS-Take 100%, divide by the # of years, and
multiply by ~70%
2. "Triple your money" formula - ANS-Tale 200%, divide by the # of years, and multply
by ~65%
3. A strategic acquirers usually prefers to pay for another company with 100% cash, if
that's the case, why would a PE firm want to use debt in an LBO? - ANS-It's a different
scneario in an LBO because:
1. The PE firms plans to sell the company in a fe years; so it's less cocnerned with
the expense of debt and more concerned with using leverage to amplify its returns
by reducuing the capital it contirbutes upfront.
2. In an LBO, the comapny is respomsible for repaying the debt, so the acquired
compant assumes most of the risk. In a standard M&A deal, the buyer or
"combined entitity" carry the debt, so there's far more risk for the acquirer.
4. Can you explain how to adjust the balance sheet in an LBO model? - ANS-The
adjustments are similar to those in an M&A deal, but in an LBO, you don't
"combine:" the sellrer's balance sheet with the buyer's since the "buyer" is an
empty shell corporation.
You still write down the company's shareholders' equity and replace it with the
investor equity the PE firm is contributing, you atill create goodwill and other
intagible assets, and you might adjust the deferred tax-related items as well.
You also add the new debt and possibly adjust the exisiting debt on the L&E side
of the balance sheetl you adjust cash on the assets side for deal funding and
trsnaction fees. You may also write up or write down asset values.
You deduce one-time transaction fees from retained earnings and financing gees
from the book value of the enw debt issued.
5. Can you explain the legal structure behind a leveraged buyout and how it benefits the
PE firm? - ANS-In a leveraged buyout, the PE firms forms a "holding company"
which it owns, and then this "holding company" acquires the real company.
The banks and other lends provide the debt lend to this holding company so that
the debt is at the "HoldCo" level.
, Managers and executives at the acquired company that retain owernshio after the
deal closes also have shares in this holding company.
The structure is important beause it means that the private equity firm is NOT "on
the book" for the debt it uses in the deal: it's up to the target comapny to repay it.
Not only does the PE firm birriw other peoples' money to do the deal, but it
doesn't even borrow the money directly - the company borrows the money so the
PE firm can do the deal.
6. Describe the dofferent types of debt a PE firm might use in a leveraged buyout, and why
it might use them? - ANS-Broadly speaking, debt is split into secured debt and
nsecured debt, which some people label "bank debt" and "high-yield debt" or
"senuor debt: and "junior debt"
Secured debt consists of term loans and volvers, us back by collateral, tends to
have lower, floating interest rates, may have amortization, and uses maintenance
convenants such as restrictions on the company's EBITDA, debt/EBITDA, and
EBITDA/interest.
Early repayment if principal is allowed, maturity periods tend to be shorter,
imnvestors tend to be conservative.
Unsecured debt comsists of senior notes, suboridnated notes, and mezzanine,
and is not back by collateral; interest rates tend to be higher and fixed rathet than
floating, there is no amortization, and it uses incurrence co venants (company
can't sell assets above a certain dollar amount)
Early repayment is now allowed, maturity tends to be londer, and the investors
tend to be hedge funds, merchant banls, and mezzzanine funds.
7. How can you determine how much debt a PE firm might use in an LBO and hw many
tranches there would be? - ANS-Look at recent, simialr LBOs and use the median
debt/EBITDA lelvels from them, or also look at highly leveraged public companes
in the industry ad check their debt/EBITDA lelvels.
8. How could a private ewuity firm boosst its returns in an LBO? - ANS-The main returns
drivers are multiple expansion., EBITDA growth, and debt paydown and cash
generation, so a PE firm could improve its returns by improvoing any one of
those.
In practice, this means:
Multiple expansionL reduce the pruchase multiple and/or increase tehe exit
multiple
Questions and Answer
1. "Double your money" formula - ANS-Take 100%, divide by the # of years, and
multiply by ~70%
2. "Triple your money" formula - ANS-Tale 200%, divide by the # of years, and multply
by ~65%
3. A strategic acquirers usually prefers to pay for another company with 100% cash, if
that's the case, why would a PE firm want to use debt in an LBO? - ANS-It's a different
scneario in an LBO because:
1. The PE firms plans to sell the company in a fe years; so it's less cocnerned with
the expense of debt and more concerned with using leverage to amplify its returns
by reducuing the capital it contirbutes upfront.
2. In an LBO, the comapny is respomsible for repaying the debt, so the acquired
compant assumes most of the risk. In a standard M&A deal, the buyer or
"combined entitity" carry the debt, so there's far more risk for the acquirer.
4. Can you explain how to adjust the balance sheet in an LBO model? - ANS-The
adjustments are similar to those in an M&A deal, but in an LBO, you don't
"combine:" the sellrer's balance sheet with the buyer's since the "buyer" is an
empty shell corporation.
You still write down the company's shareholders' equity and replace it with the
investor equity the PE firm is contributing, you atill create goodwill and other
intagible assets, and you might adjust the deferred tax-related items as well.
You also add the new debt and possibly adjust the exisiting debt on the L&E side
of the balance sheetl you adjust cash on the assets side for deal funding and
trsnaction fees. You may also write up or write down asset values.
You deduce one-time transaction fees from retained earnings and financing gees
from the book value of the enw debt issued.
5. Can you explain the legal structure behind a leveraged buyout and how it benefits the
PE firm? - ANS-In a leveraged buyout, the PE firms forms a "holding company"
which it owns, and then this "holding company" acquires the real company.
The banks and other lends provide the debt lend to this holding company so that
the debt is at the "HoldCo" level.
, Managers and executives at the acquired company that retain owernshio after the
deal closes also have shares in this holding company.
The structure is important beause it means that the private equity firm is NOT "on
the book" for the debt it uses in the deal: it's up to the target comapny to repay it.
Not only does the PE firm birriw other peoples' money to do the deal, but it
doesn't even borrow the money directly - the company borrows the money so the
PE firm can do the deal.
6. Describe the dofferent types of debt a PE firm might use in a leveraged buyout, and why
it might use them? - ANS-Broadly speaking, debt is split into secured debt and
nsecured debt, which some people label "bank debt" and "high-yield debt" or
"senuor debt: and "junior debt"
Secured debt consists of term loans and volvers, us back by collateral, tends to
have lower, floating interest rates, may have amortization, and uses maintenance
convenants such as restrictions on the company's EBITDA, debt/EBITDA, and
EBITDA/interest.
Early repayment if principal is allowed, maturity periods tend to be shorter,
imnvestors tend to be conservative.
Unsecured debt comsists of senior notes, suboridnated notes, and mezzanine,
and is not back by collateral; interest rates tend to be higher and fixed rathet than
floating, there is no amortization, and it uses incurrence co venants (company
can't sell assets above a certain dollar amount)
Early repayment is now allowed, maturity tends to be londer, and the investors
tend to be hedge funds, merchant banls, and mezzzanine funds.
7. How can you determine how much debt a PE firm might use in an LBO and hw many
tranches there would be? - ANS-Look at recent, simialr LBOs and use the median
debt/EBITDA lelvels from them, or also look at highly leveraged public companes
in the industry ad check their debt/EBITDA lelvels.
8. How could a private ewuity firm boosst its returns in an LBO? - ANS-The main returns
drivers are multiple expansion., EBITDA growth, and debt paydown and cash
generation, so a PE firm could improve its returns by improvoing any one of
those.
In practice, this means:
Multiple expansionL reduce the pruchase multiple and/or increase tehe exit
multiple
