LBO Questions and Answers
1. A company has $100m of EBITDA. It grows to $120m in 5 years. Each year you paid
down $25m of debt. Let's say you bought the company for 5x and sold it 5.5x. How much
equity value did you create? How much is attributed to each strategy of creating equity
value? - ANS-The purchase price is $500m = $100m * 5x
Exit is $660m
Total profit is $160m + debt paydown of $125m
Total equity value increase by $285m
Debt paydown contributed $125m
EBITDA growth contributed $100m ($20 *.5x)
Multiple expansion contributed the remaining $60m (5.5x-5x) * 120m
2. A company runs two operating subsidiaries. One sells coffee and one sells doughnuts.
You own 100% of the coffee subsidiary and 80% of the doughnut subsidiary. Coffee
generates $100m of EBITDA vs. $200m for the doughnut subsidiary. Doughnut
companies are worth 5x, the parent share price is $10 and there are 100m shares. The
company has cash of debt of $500 and cash of $200m. What's the EV multiple for this
company? - ANS-The parent EV build is
$1,000 equity value + $300m net debt
Plus: minority int from doughnut sub
Calculate as $200 * 5x * (1-.8) = $200m
EV = $1500
EBITDA = $100m + $200m = $300m
3. Advantages of LBO financing - ANS-1) As the debt ratio increases, equity portion
shrinks to a level where one can acquire a company by only putting up 20-40% of
the total purchase price
2) interest payments are tax deductible
3) by having management investing, the firm guarantees the management team's
incentives will be aligned with their own
4. Assume the following scenario: EBITDA of $10m and FCF of $15m. Entry = exit at 5x.
Leverage = 3x. At the time of exit, 50% of debt is paid down. You must generate a 3x
return. 20% of the options are given to management. At what price must you sell the
business. - ANS-Start with Purchase price: 5x * $10 = $50m EV
Starting leverage is 3x so EV - $30m = $20m starting equity
Then, you know you need to back into 3x return ($20m * 3x = $60m)
give 20% of options to management at end of year 3, so 60m/(1-20%) = $75m exit
equity value
, Then, lastly, add the ending debt (less repayment) = $15m to $90m EV at exit
5. At the end of the day, what is PE all about? - ANS-risk mitigation and value creation
6. Bond yield - ANS-interest paid / bond price
7. Calculating revolver commitment fee - ANS-Fixed rate * (the revolver's limit - any
undrawn amount)
8. Do you need to project all 3 statements in an LBO model? Are there any shortcuts? -
ANS-do not need full BS, just track debt and make assumptions about NWC
do not need full IS or SCF just the line items for debt repayment
9. Does enterprise value include working capital? - ANS-Yes--affects cash flow and
therefore value of an investment
10. Due Diligence: Competitive Advantage / SWOT - ANS-1. Competitive advantage /
SWOT analysis:
- Pricing
- Differentiation (performance, reliability, durability, features, perceived quality and
brand)
- Niche / specialty
- Leveragability of skills / technology for entry
11. Due Diligence: Management Team and Culture - ANS-2. Management team and
culture
- Experience and competence (length of tenure, backgrounds)
- Industry connections (strength with buyers / suppliers)
- Equity stake in the business / founders?
- Rigid or fluid culture / HR issues like union or labor problems?
12. Due Diligence: Operating Performance - ANS-5. Operating performance
-What is the resilience of the company to downturns?
-What demographics is the revenue focused in?
-What is the cost structure, how efficient are the supply and distribution chains?
-What's the proportion of fixed to variable vosts?
-How well do you utilize assets/
-Ask about capex, growth vs. maintenance
-Also ask about how working capital is managed
-How well do you collect on account receivables or manage accounts payable?
-How much cash is available right now?
-Are there any material, undisclosed off balance sheet liabilities?
13. Due Diligence: Opportunities - ANS-6. Opportunities
-Are there non-core or unprofitable assets or business lines?
-Is there opportunity for improvement or rationalization?
-What's your exit strategy here?
-Is industry consolidating so that a sale might be made easier?
-What impact will an acquisition and financial leverage have on the operations of
the business? Will key customers be spooked?
14. Due Diligence: Profitability - ANS-4. Profitability analysis
, - Zero in on growth: how much growth in projected and how much is attributed to
growth of the industry vs. market share gains? realistic projections?
- What are the projected financials?
- Opportunities to increase revenue
A) increase prices (differentiation, customer service, brand strength, demand
elasticity)
B) increase volume (increase market share, move products, improve tech,
fundamental growth)
-Opportunities to decrease costs?
(concentrate purchasing, overhead reduction, outsource non core competencies,
identify cost drivers, eliminate fixed or variable costs, efficient supply channels,
increase economies of scale)
15. Due Diligence: Supply Chain Analysis - ANS-3. Supply chain analysis
- Primary activities: R&D > inbound logistics > operations > distribution > sales &
marketing > service
- Support activities: Co. infrastructure, human resources, info tech
16. Due Diligence: What firm specific questions would you ask? - ANS-Then more into
company's own operating performance to determine how well positioned the
company is within that industry
1. Competitive advantage / SWOT analysis:
2. Management team and culture
3. Supply chain analysis
4. Profitability analysis
5. Operating performance
6. Opportunities
17. Due diligence: What industry specific questions would you ask? - ANS-You might start
off with industry questions to determine if it is an industry that the sponsor would
want to be in, then determine how well positioned the company is within that
industry (i.e. think about market rivalry, whether the industry is growing, what the
company and its competitors respective market shares are, what the primary
strategy for product competition (brand / quality price). Ask whether there are
barriers to entry or economies of scale, supplier and buyer power, threat of
substitutes, et.c
18. Explain a few drivers of purchase multiples of a business. - ANS-1. growth: revenue
growth = main tool to achieve non-geared value creation
2. ROIC
3. Business size: large business usually has a larger market share, more stability,
more attractive to buyers and therefore demands a premium
4. stability
5. diversification
6. capex--want less
1. A company has $100m of EBITDA. It grows to $120m in 5 years. Each year you paid
down $25m of debt. Let's say you bought the company for 5x and sold it 5.5x. How much
equity value did you create? How much is attributed to each strategy of creating equity
value? - ANS-The purchase price is $500m = $100m * 5x
Exit is $660m
Total profit is $160m + debt paydown of $125m
Total equity value increase by $285m
Debt paydown contributed $125m
EBITDA growth contributed $100m ($20 *.5x)
Multiple expansion contributed the remaining $60m (5.5x-5x) * 120m
2. A company runs two operating subsidiaries. One sells coffee and one sells doughnuts.
You own 100% of the coffee subsidiary and 80% of the doughnut subsidiary. Coffee
generates $100m of EBITDA vs. $200m for the doughnut subsidiary. Doughnut
companies are worth 5x, the parent share price is $10 and there are 100m shares. The
company has cash of debt of $500 and cash of $200m. What's the EV multiple for this
company? - ANS-The parent EV build is
$1,000 equity value + $300m net debt
Plus: minority int from doughnut sub
Calculate as $200 * 5x * (1-.8) = $200m
EV = $1500
EBITDA = $100m + $200m = $300m
3. Advantages of LBO financing - ANS-1) As the debt ratio increases, equity portion
shrinks to a level where one can acquire a company by only putting up 20-40% of
the total purchase price
2) interest payments are tax deductible
3) by having management investing, the firm guarantees the management team's
incentives will be aligned with their own
4. Assume the following scenario: EBITDA of $10m and FCF of $15m. Entry = exit at 5x.
Leverage = 3x. At the time of exit, 50% of debt is paid down. You must generate a 3x
return. 20% of the options are given to management. At what price must you sell the
business. - ANS-Start with Purchase price: 5x * $10 = $50m EV
Starting leverage is 3x so EV - $30m = $20m starting equity
Then, you know you need to back into 3x return ($20m * 3x = $60m)
give 20% of options to management at end of year 3, so 60m/(1-20%) = $75m exit
equity value
, Then, lastly, add the ending debt (less repayment) = $15m to $90m EV at exit
5. At the end of the day, what is PE all about? - ANS-risk mitigation and value creation
6. Bond yield - ANS-interest paid / bond price
7. Calculating revolver commitment fee - ANS-Fixed rate * (the revolver's limit - any
undrawn amount)
8. Do you need to project all 3 statements in an LBO model? Are there any shortcuts? -
ANS-do not need full BS, just track debt and make assumptions about NWC
do not need full IS or SCF just the line items for debt repayment
9. Does enterprise value include working capital? - ANS-Yes--affects cash flow and
therefore value of an investment
10. Due Diligence: Competitive Advantage / SWOT - ANS-1. Competitive advantage /
SWOT analysis:
- Pricing
- Differentiation (performance, reliability, durability, features, perceived quality and
brand)
- Niche / specialty
- Leveragability of skills / technology for entry
11. Due Diligence: Management Team and Culture - ANS-2. Management team and
culture
- Experience and competence (length of tenure, backgrounds)
- Industry connections (strength with buyers / suppliers)
- Equity stake in the business / founders?
- Rigid or fluid culture / HR issues like union or labor problems?
12. Due Diligence: Operating Performance - ANS-5. Operating performance
-What is the resilience of the company to downturns?
-What demographics is the revenue focused in?
-What is the cost structure, how efficient are the supply and distribution chains?
-What's the proportion of fixed to variable vosts?
-How well do you utilize assets/
-Ask about capex, growth vs. maintenance
-Also ask about how working capital is managed
-How well do you collect on account receivables or manage accounts payable?
-How much cash is available right now?
-Are there any material, undisclosed off balance sheet liabilities?
13. Due Diligence: Opportunities - ANS-6. Opportunities
-Are there non-core or unprofitable assets or business lines?
-Is there opportunity for improvement or rationalization?
-What's your exit strategy here?
-Is industry consolidating so that a sale might be made easier?
-What impact will an acquisition and financial leverage have on the operations of
the business? Will key customers be spooked?
14. Due Diligence: Profitability - ANS-4. Profitability analysis
, - Zero in on growth: how much growth in projected and how much is attributed to
growth of the industry vs. market share gains? realistic projections?
- What are the projected financials?
- Opportunities to increase revenue
A) increase prices (differentiation, customer service, brand strength, demand
elasticity)
B) increase volume (increase market share, move products, improve tech,
fundamental growth)
-Opportunities to decrease costs?
(concentrate purchasing, overhead reduction, outsource non core competencies,
identify cost drivers, eliminate fixed or variable costs, efficient supply channels,
increase economies of scale)
15. Due Diligence: Supply Chain Analysis - ANS-3. Supply chain analysis
- Primary activities: R&D > inbound logistics > operations > distribution > sales &
marketing > service
- Support activities: Co. infrastructure, human resources, info tech
16. Due Diligence: What firm specific questions would you ask? - ANS-Then more into
company's own operating performance to determine how well positioned the
company is within that industry
1. Competitive advantage / SWOT analysis:
2. Management team and culture
3. Supply chain analysis
4. Profitability analysis
5. Operating performance
6. Opportunities
17. Due diligence: What industry specific questions would you ask? - ANS-You might start
off with industry questions to determine if it is an industry that the sponsor would
want to be in, then determine how well positioned the company is within that
industry (i.e. think about market rivalry, whether the industry is growing, what the
company and its competitors respective market shares are, what the primary
strategy for product competition (brand / quality price). Ask whether there are
barriers to entry or economies of scale, supplier and buyer power, threat of
substitutes, et.c
18. Explain a few drivers of purchase multiples of a business. - ANS-1. growth: revenue
growth = main tool to achieve non-geared value creation
2. ROIC
3. Business size: large business usually has a larger market share, more stability,
more attractive to buyers and therefore demands a premium
4. stability
5. diversification
6. capex--want less
