WSP- LBO Questions and Answers
1. "How do financial sponsors "exit" their investments?" - ANS-"There are four common
ways that sponsors exit their investments:
1) Sale to a strategic acquirer.
2) sale to another financial buyer ("secondary buyer").
3) Take the company public through an IPO. 4) A recapitalization, whereby the
sponsors add more debt to the business (presumably after they've paid down
some of the debt or have significantly grown the value of the business) and use
the proceeds to fund a dividend to themselves. "
2. "Since senior debt is cheaper, why don't financial sponsors fund the entire debt portion of
the capital structure with senior debt?" - ANS-"Senior lenders will only lend up to a
certain point- usually 2-3x EBITDA, beyond which only costlier debt is available.
This is because the more debt a company incurs, the higher its risk of default. The
lowest rate senior debt enjoys the lowest risk due to its seniority in the capital
structure and imposes the strictest limits on the business via covenants, requires
secured interest(s). Subordinated, junior debt is less restrictive but requires the
highest interest rates. "
3. "What is a management buyout ("MBO")" - ANS-"A MBO is a leveraged buyout where
the major (or at least a significant) portion of the newco equity comes from oldco
management. Management will usually provide cash equity and rollover any
existing equity. In addition, equity financing can also include financial sponsors or
other investors. The debt financing portion of the MBO is similar to that of an LBO.
"
4. "When analyzing the viability of undertaking an LBO, how do private equity firms
estimate the value of the business in the exit year?" - ANS-"The most common
approach is to assume that the company will be exited at the same EV/EBITDA
multiple that it was acquired at. For example, if sponsors are contemplating an
LBO where the purcahse price reflects a 10x EV/EBITDA multiple, the exit year
assumption (usually 5-7 years from the LBO date) will likely be that they will be
able ot sell at the same 10x multiple. Because of the importance of this
assumption in determining the attractiveness of the deal to its financial sponsor
(i.e. the deal's IRR), this exit multiple assumptions is often sensitized and IRRs are
presented for a range of possible exit multiples. "
5. How might operating a highly levered company be different from operating a company
with little or no debt? - ANS-"Highly levered companies have a lower margin of error
due to high fixed debt relayed payments (interest and principal). This forces
management to become extremely disciplined with costs, to become more
conservative when it comes to capital spending and embarking on new initiatives
and acquisitions. It increases the importance of effective planning and instituting
better financial controls. "
1. "How do financial sponsors "exit" their investments?" - ANS-"There are four common
ways that sponsors exit their investments:
1) Sale to a strategic acquirer.
2) sale to another financial buyer ("secondary buyer").
3) Take the company public through an IPO. 4) A recapitalization, whereby the
sponsors add more debt to the business (presumably after they've paid down
some of the debt or have significantly grown the value of the business) and use
the proceeds to fund a dividend to themselves. "
2. "Since senior debt is cheaper, why don't financial sponsors fund the entire debt portion of
the capital structure with senior debt?" - ANS-"Senior lenders will only lend up to a
certain point- usually 2-3x EBITDA, beyond which only costlier debt is available.
This is because the more debt a company incurs, the higher its risk of default. The
lowest rate senior debt enjoys the lowest risk due to its seniority in the capital
structure and imposes the strictest limits on the business via covenants, requires
secured interest(s). Subordinated, junior debt is less restrictive but requires the
highest interest rates. "
3. "What is a management buyout ("MBO")" - ANS-"A MBO is a leveraged buyout where
the major (or at least a significant) portion of the newco equity comes from oldco
management. Management will usually provide cash equity and rollover any
existing equity. In addition, equity financing can also include financial sponsors or
other investors. The debt financing portion of the MBO is similar to that of an LBO.
"
4. "When analyzing the viability of undertaking an LBO, how do private equity firms
estimate the value of the business in the exit year?" - ANS-"The most common
approach is to assume that the company will be exited at the same EV/EBITDA
multiple that it was acquired at. For example, if sponsors are contemplating an
LBO where the purcahse price reflects a 10x EV/EBITDA multiple, the exit year
assumption (usually 5-7 years from the LBO date) will likely be that they will be
able ot sell at the same 10x multiple. Because of the importance of this
assumption in determining the attractiveness of the deal to its financial sponsor
(i.e. the deal's IRR), this exit multiple assumptions is often sensitized and IRRs are
presented for a range of possible exit multiples. "
5. How might operating a highly levered company be different from operating a company
with little or no debt? - ANS-"Highly levered companies have a lower margin of error
due to high fixed debt relayed payments (interest and principal). This forces
management to become extremely disciplined with costs, to become more
conservative when it comes to capital spending and embarking on new initiatives
and acquisitions. It increases the importance of effective planning and instituting
better financial controls. "
