Street of Walls - Private Equity or LBO-specific questions and correct answers

What is an LBO? In a leveraged buyout, 1) PE firm acquires a company using D + E 2) Operates it for a several years with operating improvements 3) sells it at the end of the period to realize a return on that investment Walk me through the mechanics of an LBO model. 1) Assumptions 2) S&U 3) Adjust Balance Sheet - Debt and Equity - Goodwill 4) Project 3 statements 5) Project FCF 6) Debt and Interest Schedule 7) Exit Calc (MOic and IRR) 8) Sensitivity Tables How do you assess credit risk? Leverage Ratios (never exceed 4x) (debt / equity - under 2x) Interest-coverage ratios (greater than 1 - maintenance - above 3x) Fixed Charge Coverage Ratio Look at the industry, growth. Credit - protection against bankruptcy Industry and Company perspective What are the different types of PE firms? 1) (EARLY STAGE) VC (5-10% - preferred equity or warrants) 2) (MID STAGE) Growth Equity (10-30%) 3) (LATE STAGE) LBO (20-50%) What makes a good LBO investment candidate? (S) Stable Cash FLows (A) assets (M) Margins (C) Low CapEx (L) Low - Risk (U) Undervalued (B) Badass Management What are the different ways to find the valuation of a company? (1) Precedent Tran. (2) Public Comps (3) DCF (4) LBO (5) NAV (6) SOTP How would you spend a million dollars if it were given to you? I would consider the investment options available to me (1) PE co-invest (2) bonds and (3) equities. I do not want to invest in something I do not understand well. Since I am 25 and won't be retiring for awhile, I want a high rate of return. (1) 10% PE coinvest - high return, BUT illiquid, investments of employer (2) 60% diversified stocks - (passive equity funds) - between domestic and international (half and half) (3) 30% bonds, low-cost, medium-maturity bonds (2-10 years)- uncorrelated with equity - buy a home in 5 years. Company A has a potential IRR of 23% and Company B has a potential IRR of 30%. What 2 questions would you ask before you decide which one to invest in? 1) How much investment 2) Timing 3) What industry to they operate in? What are the 4 main drivers of the change in IRR for an LBO scenario? 1) Lower purchase 2) Exit Multiple 3) Amount of Leverage 4) EBITDA expansion How do you model in PIK notes? EASY Walk me through the calculation of Free Cash Flow. EBITDA Less: Interest Less: Taxes Less: CapEx Less: Change in NWC Why would a private equity firm use a convertible preferred note? How do you calculate amortization of intangible assets? Typically companies will do a FMV of their intangible assets 5% or less (model it) What are the uses of excess cash flow? If the borrower has excess cash and the terms of the debt provide for early repayment at the borrower's option, the borrower may use excess cash to periodically repay debt ahead of schedule. This is called "cash sweep." What makes for a good management team? (1) Solid MGMT team with experience (2) A team that has weathered storms (3) Been through an acquisition before What 3 questions would you ask a CEO of a company you were looking to invest in? (1) Market Leader (growth) (2) Secret Sauce (special patents, proprietary) (3) Historical performance (where do you see your company growing in the future) (4) KPIs You have two companies with different EV/EBITDA multiples in different industries. What are some reasons why their EBITDA multiples might be different? (1) Fraud / Skiddish (2) Market leader (3) Position of the industry What is the difference between senior and subordinated notes? 1) Seniority - senior debt gets paid first in a bankruptcy 2) Covenants - (bank - covenants) What are the key considerations to structuring a carve-out transaction?