LBO Theory & Modeling Questions and
Answers
1. Add-On Acquisitions (2) - ANS-1. To drive additional INORGANIC GROWTH (e.g.
roll-up strategy)
2. To model add-on acquisitions...
i.) Calculate cash OUTFLOW of buying company
ii.) Conduct SEPARATE forecast (then add to Main Forecast)
2. Assumptions that Increase Sponsor Equity Required (3) - ANS-1. Offer Premium /
Purchase Price
- Higher = More sponsor equity
2. Refinancing Debt (paying it off)
- More sponsor equity
3. Leverage Used
- Lower = More sponsor equity
3. Balance Sheet Projections (10) - ANS-1. Cash (C/F)
- If SWEEP: Hold CONSTANT
2. Net Working Capital
i.) A/R, Inventory, A/P: Days
ii.) Other Current: % of Sales
3. PP&E (PP&E Schedule)
- Closing = Opening + Capex - Depreciation
4. Goodwill
- Hold CONSTANT from New Goodwill
5. Deferred Financing Fees (Debt Schedule)
6. Intangible Assets
7. Other Non-Current
- Hold CONSTANT
8. Debt Instruments (Debt Schedule)
- Closing = Opening - Mandatory Repayments - Discretionary Repayments +
Accumulated PIK Interest
, 9. Deferred Tax Liability
10. Shareholder Equity
- Closing = Opening + Net Income - Dividends
- Transaction Fees deducted from SHEQ
- PF Equity = (SPONSOR EQUITY + Management Roll-over) - Transaction Expense
4. Cash Sweep - ANS-Require all EXCESS CASH be used to PAY DOWN debt (in order
of seniority)
- Cash on B/S will remain unchanged YoY
5. Cash-Free Debt-Free (4) - ANS-1. Assume you are REFINANCING DEBT and using
existing CASH to pay down
- Primarily for Private Company LBOs
2. Impact to 3-Statements
i.) Cash and Debt both go to 0 on B/S
3. Impact to Sources & Uses
i.) Use: Purchase Price = EV (not equity value)
ii.) Sources: NO CHANGES needed as Investor Equity acts as the plug (lower
sources = lower equity)
4. How to Use Debt / Cash to Lower Deal Price
i.) If Target's Debt > Cash: Target uses entire cash balance to REPAY debt,
Acquiror repays rest when it completes deal
ii.) If Target's Cash > Debt: Target repays entire debt balance, and then uses extra
remaining cash to REPURCHASE SHARES or ISSUE SPECIAL DIVIDEND to
shareholders
6. Common Things to Identify in LBO - ANS-1. If Debt all Paid Off
i.) Could have RAISED MORE debt
ii.) Could have argued for a LOWER INTEREST RATE (since debt paid down)
2. Decreasing IRR over Time
i.) Means Cash Flows are getting worse
3. Low IRR / MoC
i.) Not enough leverage
7. Criteria for Good LBO Candidates (8) - ANS-1. Strong MARKET POSITION and
Sustainable COMPETITIVE ADVANTAGES
i.) Higher barriers to entry
ii.) High switching costs
iii.) Strong customer relationships
2. Multiple Avenues of GROWTH
, i.) Intro of new products
ii.) Increasing number of locations
iii.) New customers / increasing penetration of existing customers
iv.) Expanding new geographies
3. Stable, Recurring CASH FLOWS
i.) Low exposure to seasonal fluctuations
ii.) Low sensitivity to cyclical fluctuations (e.g. economy, commodity)
4. Low Maintenance CAPEX
5. SECULAR / Defensive Industry Trends
- Examples: Automation, digital acceleration, changing demographics, increasing
regulation
6. Strong MANAGEMENT Team
7. Multiple Areas to CREATE VALUE
i.) Sell underperforming assets
ii.) Increase efficiency of operations
iii.) Pricing optimization
iv.) Organizational structure
v.) Diversifying customer base
8. Solid Base of ASSETS
- To use as collateral for debt
8. D/E Funding % - Determination (2) - ANS-1. Factors Impacting Debt Capacity
(depends on industry, company, structural, and market)
i.) Determining "financeable" EBITDA
ii.) Maintenance vs. Growth Capex
iii.) Avg. vs. Peak Working Capital Requirements
iv.) Historical Performance
v.) Achievability of Projections
vi.) Depth and Quality of Management
vii.) Growth Capability Given Leverage Constraints
viii.) Structural Risk (e.g. size, leverage, coverage)
ix.) Precedent LBO Transactions (rely on bankers)
2. D/E Funding %
- Ranges from 25%/75% to 45%/55%
9. D/E to D/V (2) - ANS-1. D/V = D/E/(1+D/E)
- If D/E, ADD
2. D/E = D/V/(1-D/V)
Answers
1. Add-On Acquisitions (2) - ANS-1. To drive additional INORGANIC GROWTH (e.g.
roll-up strategy)
2. To model add-on acquisitions...
i.) Calculate cash OUTFLOW of buying company
ii.) Conduct SEPARATE forecast (then add to Main Forecast)
2. Assumptions that Increase Sponsor Equity Required (3) - ANS-1. Offer Premium /
Purchase Price
- Higher = More sponsor equity
2. Refinancing Debt (paying it off)
- More sponsor equity
3. Leverage Used
- Lower = More sponsor equity
3. Balance Sheet Projections (10) - ANS-1. Cash (C/F)
- If SWEEP: Hold CONSTANT
2. Net Working Capital
i.) A/R, Inventory, A/P: Days
ii.) Other Current: % of Sales
3. PP&E (PP&E Schedule)
- Closing = Opening + Capex - Depreciation
4. Goodwill
- Hold CONSTANT from New Goodwill
5. Deferred Financing Fees (Debt Schedule)
6. Intangible Assets
7. Other Non-Current
- Hold CONSTANT
8. Debt Instruments (Debt Schedule)
- Closing = Opening - Mandatory Repayments - Discretionary Repayments +
Accumulated PIK Interest
, 9. Deferred Tax Liability
10. Shareholder Equity
- Closing = Opening + Net Income - Dividends
- Transaction Fees deducted from SHEQ
- PF Equity = (SPONSOR EQUITY + Management Roll-over) - Transaction Expense
4. Cash Sweep - ANS-Require all EXCESS CASH be used to PAY DOWN debt (in order
of seniority)
- Cash on B/S will remain unchanged YoY
5. Cash-Free Debt-Free (4) - ANS-1. Assume you are REFINANCING DEBT and using
existing CASH to pay down
- Primarily for Private Company LBOs
2. Impact to 3-Statements
i.) Cash and Debt both go to 0 on B/S
3. Impact to Sources & Uses
i.) Use: Purchase Price = EV (not equity value)
ii.) Sources: NO CHANGES needed as Investor Equity acts as the plug (lower
sources = lower equity)
4. How to Use Debt / Cash to Lower Deal Price
i.) If Target's Debt > Cash: Target uses entire cash balance to REPAY debt,
Acquiror repays rest when it completes deal
ii.) If Target's Cash > Debt: Target repays entire debt balance, and then uses extra
remaining cash to REPURCHASE SHARES or ISSUE SPECIAL DIVIDEND to
shareholders
6. Common Things to Identify in LBO - ANS-1. If Debt all Paid Off
i.) Could have RAISED MORE debt
ii.) Could have argued for a LOWER INTEREST RATE (since debt paid down)
2. Decreasing IRR over Time
i.) Means Cash Flows are getting worse
3. Low IRR / MoC
i.) Not enough leverage
7. Criteria for Good LBO Candidates (8) - ANS-1. Strong MARKET POSITION and
Sustainable COMPETITIVE ADVANTAGES
i.) Higher barriers to entry
ii.) High switching costs
iii.) Strong customer relationships
2. Multiple Avenues of GROWTH
, i.) Intro of new products
ii.) Increasing number of locations
iii.) New customers / increasing penetration of existing customers
iv.) Expanding new geographies
3. Stable, Recurring CASH FLOWS
i.) Low exposure to seasonal fluctuations
ii.) Low sensitivity to cyclical fluctuations (e.g. economy, commodity)
4. Low Maintenance CAPEX
5. SECULAR / Defensive Industry Trends
- Examples: Automation, digital acceleration, changing demographics, increasing
regulation
6. Strong MANAGEMENT Team
7. Multiple Areas to CREATE VALUE
i.) Sell underperforming assets
ii.) Increase efficiency of operations
iii.) Pricing optimization
iv.) Organizational structure
v.) Diversifying customer base
8. Solid Base of ASSETS
- To use as collateral for debt
8. D/E Funding % - Determination (2) - ANS-1. Factors Impacting Debt Capacity
(depends on industry, company, structural, and market)
i.) Determining "financeable" EBITDA
ii.) Maintenance vs. Growth Capex
iii.) Avg. vs. Peak Working Capital Requirements
iv.) Historical Performance
v.) Achievability of Projections
vi.) Depth and Quality of Management
vii.) Growth Capability Given Leverage Constraints
viii.) Structural Risk (e.g. size, leverage, coverage)
ix.) Precedent LBO Transactions (rely on bankers)
2. D/E Funding %
- Ranges from 25%/75% to 45%/55%
9. D/E to D/V (2) - ANS-1. D/V = D/E/(1+D/E)
- If D/E, ADD
2. D/E = D/V/(1-D/V)
