LBO Analysis Questions and Answers
1. Can mezz debt ever have a higher cost than the cost of equity? - ANS-No because
mezz debt is senior to equity
2. Can you use a section 338(h)(10) election in an LBO? - ANS-No because the financial
sponsor (the acquirer) is not a C corporation and the acquiring company must be
a C corporation in order to use a Section 38(h)(10) election.
3. Could a financial sponsor ever recognize synergies off of a company they acquire? -
ANS-Yes is they already have a company in their portfolio that has some business
overlap. Often times this is a common strategy in an LBO where a foundation
company is purchased and then bolt on acquisitions are made to create value for
the combined companies.
4. Could Mezz debt ever have a higher cost than the cost of equity for a PE fund? -
ANS-No because Mezz debt is senior to equity
5. Describe a company you think would be a good LBO candidate. - ANS-Cooper Tire
6. Difference between a dividend recap and a leverage recap? - ANS-A leverage recap is
when a company takes on a large amount of debt to pay a dividend to
shareholders or to repurchase shares. A dividend recap is a type of leveraged
recap. A dividend recap is different from a normal dividend in that it is funded
through debt instead of a company's earnings.
7. Difference between bank debt and high yield debt? - ANS-This is a simplification, but
broadly speaking there are 2 "types" of debt: "bank debt" and "high-yield debt."
There are many differences, but here are a few of the most important ones:
• High-yield debt tends to have higher interest rates than bank debt (hence the
name "high-yield").
• High-yield debt interest rates are usually fixed, whereas bank debt interest rates
are "floating" - they change based on LIBOR or the Fed interest rate.
• High-yield debt has incurrence covenants while bank debt has maintenance
covenants. The main difference is that incurrence covenants prevent you from
doing something (such as selling an asset, buying a factory, etc.) while
maintenance covenants require you to maintain a minimum financial performance
(for example, the Debt/EBITDA ratio must be below 5x at all times).
• Bank debt is usually amortized - the principal must be paid off over time -
whereas with high-yield debt, the entire principal is due at the end (bullet
maturity).
Usually in a sizable Leveraged Buyout, the PE firm uses both types of debt.
8. Difference between LBOs and mergers? - ANS-LBOS- buying it to resell it which is
why you employ leverage. Synergies if ther are portfolio companies
Look a metrics based off selling the asset to look at your return
Mergers- buying to hold it for the long term which is why they use the cheapest
form of financing. Can also sometimes realize synergies. Look at metrics like EPS
,9. Difference between Second Lien and First Lien term loans? - ANS-First Lien includes
Term Loan A and term Loan B. Second Lien is subordinated to Term Loans A and
B and are senior to high yield bonds. They are secured by any assets that don't
secure First Lien term loans
10.Does minority interest dilute returns for the financial sponsor? - ANS-No
11.How are debt financing fees treated in an LBO? - ANS-They are capitalized and
amortized over the life of the debt.
12.How are early repayment options structured in an LBO? Why do the sponsors structure
the debt this way? - ANS-Bank debt is amortized
High yeld debt..
The debt covenants allow for early debt repayment if the debt is repaid at a
premium. The PE firm would want to have this option just in case cheaper debt
financing becomes available at some point in the future.
13.How could a financial sponsor use mezz in an LBO? - ANS-Could use Mezz debt to
increase you leverage and boost your overall return. While Mezz debt is the most
subordinated trache of debt, it reduces cash outflows through things like
convertible debt and PIK debt
14.How could increasing leverage reduce IRR? - ANS-If you increase leverage so much
that a company cannot service its interest / principal repayments then you will
likely be decreasing your IRR at the expense of adding additional leverage.
Leverage can also be increased so that a company could still service its interest
payments but wouldn't have any excess cash to pay down prinicpal on debt.
15.How do changing interest rates affect debt in an LBO? - ANS-Would only affect the
bank debt since this is floating rate. Could also affect fixed rate debt in that it
would change their market values and the price the financial sponsor would have
to pay to repurchase the debt in the market. Might incentivize a company to buy
back debt
16.How do you calculate the cash on cash multiple for equity investors in an LBO? -
ANS-Take all future cash flows to equity providers, add them (do not discount
them, we are not taking into account the time value of money), and then divide
that by the initial investment. Minority interest decreases returns since you have
to subtract it out from your exit enterprise value in an LBO
17.How do you calculate the cash on cash multiples for debt investors in an LBO? -
ANS-Take all future cash flows from interest and principal repayments, add them,
and then divide them by the original cost of the security.
18.How do you calculate the IRR for debt investors in an LBO? - ANS-You calculate the
interest expense and principal repayments to debt investors each year. The debt
balance at the end of the year would be your "exit value."
19.How do you choose purchase and exit multiples for an LBO? - ANS-Comparable
companies and precedent transactions multiples. You typically would only want
you precedent transactions multiples to be based off of LBOs since financial
sponsors pay less in LBOs than a normal strategic buyer M&A.
, 20.How do you come up with the exit multiple used in an LBO model? - ANS-Try to keep it
in line with the purchase multiple to be conservative with you assumptions. Also
you could look at pre acqs or strategic buyers or PE buyouts of similar
companies, depending on your exit strategy. To determine your purchase multiple
you would use these methodologies
21.How do you determine how much you will be able to sell the target for in an LBO? -
ANS-Take the final year EBITDA and multiple it by your exit mutiple
22.How do you move from enterprise to equity value? - ANS-Enterprise value - debt
-Preferred - minority interest + cash and cash equivalents = equity value
23.How do you project the financial statements and determine how much debt the company
can pay off each year in an LBO model? - ANS-To project the cash flow available to
repay debt each year, you take Cash Flow from Operations and subtract CapEx.
From here you subtract out any mandatory debt repayments, add this to the
company's beginning cash balance for that period and subtract out the minimum
cash balance needed to run the company.
24.How do you solve for a company's purchase price in an LBO? How do you decide what
you will pay for a company in an LBO? - ANS-Back solve from a targetted IRR, use
comparable companies analysis, precendent LBO transactions, M&A premium
analysis
25.How do you use an LBO model to value a company? - ANS-Set a target IRR and back
solve to find the purchase price of the company.
26.How does a financial sponsor go about deciding what % of their debt will be financed by
high yield debt and what % will be financed by bank debt? - ANS-Obviously they want
to max out at the cheaper, more senior levels of debt, but bank appetite limits the
amount they can raise, so they turn to the more yield-hungry hy market. You will
sometimes see situations where the company's Term Loan is significantly
oversubscribed by investors, allowing companies to downsize their hy tranche
and upsize the TLB
27.How does a returns attributions analysis break down for an LBO model? - ANS-Breaks
down total return to equity investors by EBITDA growth, debt repayment, and exit
multiple expansion. Helps tell you what your driving assumptions are behind your
model
28.How does exiting an LBO earlier affect returns? - ANS-Exiting the investment earlier
increases IRR but diminishes total return, Return on cash multiple
29.How does the balance sheet change in an LBO model? - ANS-New debt is added to
the companies balance sheet and existing shareholder's equity is eliminated and
replaced by the amount of equity the financial sponsor is contributing. Cash will
change based on the amount of cash used to finance the deal. Goodwill and other
intangibles is also created. The FV of assets will also be written up.
30.How have the structure of LBOs changed in the past 30 years? - ANS-You now have to
put more equity down since lenders want more protection from default. You also
have to compete more with other PE firms and strategic buyers, pushing up the
purchase price of a company and lessening returns.
1. Can mezz debt ever have a higher cost than the cost of equity? - ANS-No because
mezz debt is senior to equity
2. Can you use a section 338(h)(10) election in an LBO? - ANS-No because the financial
sponsor (the acquirer) is not a C corporation and the acquiring company must be
a C corporation in order to use a Section 38(h)(10) election.
3. Could a financial sponsor ever recognize synergies off of a company they acquire? -
ANS-Yes is they already have a company in their portfolio that has some business
overlap. Often times this is a common strategy in an LBO where a foundation
company is purchased and then bolt on acquisitions are made to create value for
the combined companies.
4. Could Mezz debt ever have a higher cost than the cost of equity for a PE fund? -
ANS-No because Mezz debt is senior to equity
5. Describe a company you think would be a good LBO candidate. - ANS-Cooper Tire
6. Difference between a dividend recap and a leverage recap? - ANS-A leverage recap is
when a company takes on a large amount of debt to pay a dividend to
shareholders or to repurchase shares. A dividend recap is a type of leveraged
recap. A dividend recap is different from a normal dividend in that it is funded
through debt instead of a company's earnings.
7. Difference between bank debt and high yield debt? - ANS-This is a simplification, but
broadly speaking there are 2 "types" of debt: "bank debt" and "high-yield debt."
There are many differences, but here are a few of the most important ones:
• High-yield debt tends to have higher interest rates than bank debt (hence the
name "high-yield").
• High-yield debt interest rates are usually fixed, whereas bank debt interest rates
are "floating" - they change based on LIBOR or the Fed interest rate.
• High-yield debt has incurrence covenants while bank debt has maintenance
covenants. The main difference is that incurrence covenants prevent you from
doing something (such as selling an asset, buying a factory, etc.) while
maintenance covenants require you to maintain a minimum financial performance
(for example, the Debt/EBITDA ratio must be below 5x at all times).
• Bank debt is usually amortized - the principal must be paid off over time -
whereas with high-yield debt, the entire principal is due at the end (bullet
maturity).
Usually in a sizable Leveraged Buyout, the PE firm uses both types of debt.
8. Difference between LBOs and mergers? - ANS-LBOS- buying it to resell it which is
why you employ leverage. Synergies if ther are portfolio companies
Look a metrics based off selling the asset to look at your return
Mergers- buying to hold it for the long term which is why they use the cheapest
form of financing. Can also sometimes realize synergies. Look at metrics like EPS
,9. Difference between Second Lien and First Lien term loans? - ANS-First Lien includes
Term Loan A and term Loan B. Second Lien is subordinated to Term Loans A and
B and are senior to high yield bonds. They are secured by any assets that don't
secure First Lien term loans
10.Does minority interest dilute returns for the financial sponsor? - ANS-No
11.How are debt financing fees treated in an LBO? - ANS-They are capitalized and
amortized over the life of the debt.
12.How are early repayment options structured in an LBO? Why do the sponsors structure
the debt this way? - ANS-Bank debt is amortized
High yeld debt..
The debt covenants allow for early debt repayment if the debt is repaid at a
premium. The PE firm would want to have this option just in case cheaper debt
financing becomes available at some point in the future.
13.How could a financial sponsor use mezz in an LBO? - ANS-Could use Mezz debt to
increase you leverage and boost your overall return. While Mezz debt is the most
subordinated trache of debt, it reduces cash outflows through things like
convertible debt and PIK debt
14.How could increasing leverage reduce IRR? - ANS-If you increase leverage so much
that a company cannot service its interest / principal repayments then you will
likely be decreasing your IRR at the expense of adding additional leverage.
Leverage can also be increased so that a company could still service its interest
payments but wouldn't have any excess cash to pay down prinicpal on debt.
15.How do changing interest rates affect debt in an LBO? - ANS-Would only affect the
bank debt since this is floating rate. Could also affect fixed rate debt in that it
would change their market values and the price the financial sponsor would have
to pay to repurchase the debt in the market. Might incentivize a company to buy
back debt
16.How do you calculate the cash on cash multiple for equity investors in an LBO? -
ANS-Take all future cash flows to equity providers, add them (do not discount
them, we are not taking into account the time value of money), and then divide
that by the initial investment. Minority interest decreases returns since you have
to subtract it out from your exit enterprise value in an LBO
17.How do you calculate the cash on cash multiples for debt investors in an LBO? -
ANS-Take all future cash flows from interest and principal repayments, add them,
and then divide them by the original cost of the security.
18.How do you calculate the IRR for debt investors in an LBO? - ANS-You calculate the
interest expense and principal repayments to debt investors each year. The debt
balance at the end of the year would be your "exit value."
19.How do you choose purchase and exit multiples for an LBO? - ANS-Comparable
companies and precedent transactions multiples. You typically would only want
you precedent transactions multiples to be based off of LBOs since financial
sponsors pay less in LBOs than a normal strategic buyer M&A.
, 20.How do you come up with the exit multiple used in an LBO model? - ANS-Try to keep it
in line with the purchase multiple to be conservative with you assumptions. Also
you could look at pre acqs or strategic buyers or PE buyouts of similar
companies, depending on your exit strategy. To determine your purchase multiple
you would use these methodologies
21.How do you determine how much you will be able to sell the target for in an LBO? -
ANS-Take the final year EBITDA and multiple it by your exit mutiple
22.How do you move from enterprise to equity value? - ANS-Enterprise value - debt
-Preferred - minority interest + cash and cash equivalents = equity value
23.How do you project the financial statements and determine how much debt the company
can pay off each year in an LBO model? - ANS-To project the cash flow available to
repay debt each year, you take Cash Flow from Operations and subtract CapEx.
From here you subtract out any mandatory debt repayments, add this to the
company's beginning cash balance for that period and subtract out the minimum
cash balance needed to run the company.
24.How do you solve for a company's purchase price in an LBO? How do you decide what
you will pay for a company in an LBO? - ANS-Back solve from a targetted IRR, use
comparable companies analysis, precendent LBO transactions, M&A premium
analysis
25.How do you use an LBO model to value a company? - ANS-Set a target IRR and back
solve to find the purchase price of the company.
26.How does a financial sponsor go about deciding what % of their debt will be financed by
high yield debt and what % will be financed by bank debt? - ANS-Obviously they want
to max out at the cheaper, more senior levels of debt, but bank appetite limits the
amount they can raise, so they turn to the more yield-hungry hy market. You will
sometimes see situations where the company's Term Loan is significantly
oversubscribed by investors, allowing companies to downsize their hy tranche
and upsize the TLB
27.How does a returns attributions analysis break down for an LBO model? - ANS-Breaks
down total return to equity investors by EBITDA growth, debt repayment, and exit
multiple expansion. Helps tell you what your driving assumptions are behind your
model
28.How does exiting an LBO earlier affect returns? - ANS-Exiting the investment earlier
increases IRR but diminishes total return, Return on cash multiple
29.How does the balance sheet change in an LBO model? - ANS-New debt is added to
the companies balance sheet and existing shareholder's equity is eliminated and
replaced by the amount of equity the financial sponsor is contributing. Cash will
change based on the amount of cash used to finance the deal. Goodwill and other
intangibles is also created. The FV of assets will also be written up.
30.How have the structure of LBOs changed in the past 30 years? - ANS-You now have to
put more equity down since lenders want more protection from default. You also
have to compete more with other PE firms and strategic buyers, pushing up the
purchase price of a company and lessening returns.
