LBO VALUATION METHODOLOFY EXAMINED
LBO Explained
An LBO (Leveraged Buyout) is the acquisition of a company or division by a Pvt. Equity
firm or group of companies using a significant amount of debt ~ usually between 60-
70% of the cap structure (and a small proportion of equity) to finance the purchase price.
The goal is to achieve a 20+ % IRR by using the target’s cash flows to reduce the debt
incurred so that at the end of the hold period – usually through a sale – they can
maximize their rate of return on its initial equity investment.
(The sponsor’s goal is to realize an acceptable return (IRR > WACC).
In a traditional LBO, debt has typically comprised 60% to 70% of the financing
structure, with equity comprising the remaining 30% to 40%. Note that the higher the
leverage, the higher the IRR. For this reason, LBO firms aim to put up as little cash or
equity as possible and use as much debt as is feasible.
LBO Targets
Companies with stable and predictable cash flows. (Strong cash flows are needed to
service periodic interest payments and reduce debt over the duration of the investment)
Companies that are under-levered. (Necessary to accommodate more debt)
Companies with strong growth potential. (Profitable revenue growth at above-market
rates help drive sizeable returns, generating greater cashflow available for debt repayment
while simultaneously increasing EBITDA and enterprise value)
Companies with a strong asset base. (Substantial assets increase the amount of bank debt
available to the borrower – the least expensive source of debt financing – by providing
greater comfort to lenders regarding potential principal recovery in the event of a
bankruptcy.
Steps in an LBO
1. Purchase Price Assumptions
Entry EBITDA multiple. (This is key in figuring/calculating transaction enterprise
value. How would you derive the purchase multiple? Observing multiples paid for
similar LBO targets is a rule of thumb)
Implied Equity Purchase price is obtained by subtracting debt from enterprise
value and then adding cash. (For a public company, the implied equity purchase
price is calculated by multiplying the offer price per share by the target
company’s fully diluted shares outstanding)
2. Sources and Uses of Capital
Usually, you establish the Total Uses first and then you figure how you would
raise the capital aka Sources.
LBO Explained
An LBO (Leveraged Buyout) is the acquisition of a company or division by a Pvt. Equity
firm or group of companies using a significant amount of debt ~ usually between 60-
70% of the cap structure (and a small proportion of equity) to finance the purchase price.
The goal is to achieve a 20+ % IRR by using the target’s cash flows to reduce the debt
incurred so that at the end of the hold period – usually through a sale – they can
maximize their rate of return on its initial equity investment.
(The sponsor’s goal is to realize an acceptable return (IRR > WACC).
In a traditional LBO, debt has typically comprised 60% to 70% of the financing
structure, with equity comprising the remaining 30% to 40%. Note that the higher the
leverage, the higher the IRR. For this reason, LBO firms aim to put up as little cash or
equity as possible and use as much debt as is feasible.
LBO Targets
Companies with stable and predictable cash flows. (Strong cash flows are needed to
service periodic interest payments and reduce debt over the duration of the investment)
Companies that are under-levered. (Necessary to accommodate more debt)
Companies with strong growth potential. (Profitable revenue growth at above-market
rates help drive sizeable returns, generating greater cashflow available for debt repayment
while simultaneously increasing EBITDA and enterprise value)
Companies with a strong asset base. (Substantial assets increase the amount of bank debt
available to the borrower – the least expensive source of debt financing – by providing
greater comfort to lenders regarding potential principal recovery in the event of a
bankruptcy.
Steps in an LBO
1. Purchase Price Assumptions
Entry EBITDA multiple. (This is key in figuring/calculating transaction enterprise
value. How would you derive the purchase multiple? Observing multiples paid for
similar LBO targets is a rule of thumb)
Implied Equity Purchase price is obtained by subtracting debt from enterprise
value and then adding cash. (For a public company, the implied equity purchase
price is calculated by multiplying the offer price per share by the target
company’s fully diluted shares outstanding)
2. Sources and Uses of Capital
Usually, you establish the Total Uses first and then you figure how you would
raise the capital aka Sources.
