LBO Interview Questions
What is a leveraged buyout, and why does it work? - ANSIn a leveraged buyout (LBO), a private
equity firm acquires a company using a combination of debt and equity, operates it for several
years, possibly makes operational improvements, and then sells the company at the end of the
period to realize a return on investment.
During the period of ownership the PE firm uses the company's cash flows to pay interest
expense from the debt and to pay off debt principal.
An LBO delivers higher returns than if the PE firm used 100% cash for the following reasons:
1. By using debt, the PE firm reduces the up-front cash payment for the company, which boosts
returns
2. Using the company's cash flows to repay debt principal and pay debt interest also produces a
better return than keeping the cash flows
3. The PE firm sells the company in the future which allows it to regain the majority of the funds
spent to acquire it in the first place
Why do PE firms use leverage when buying a company? - ANSThey use leverage to increase
their returns.
Any debt raised for an LBO is not "your money" - so if you're paying $5 billion for a company its
easier to earn a high return on $2 billion of your own money and $3 billion borrowed than it is on
$5 billion of your own money.
A secondary benefit is that the firm also has more capital available to purchase other
companies.
Walk me through a basic LBO model. - ANS"In an LBO model Step 1 is making assumptions
about the purchase price, debt/equity ratio, Interest rate on debt and other variables; might also
assume something about the company's operations such as revenue growth or margins.
Step 2 is to create a sources & uses section which shows how the transaction is financed and
what the capital is used for, also tells you how much Investor Equity is required
step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figure, allocate the
purchase price, and add in Goodwill & other Intangibles on the Assets side to make everything
balance
In Step 4, you project out the company's Income Statement, balance Sheet and Cash Flow
statement and determine how much debt is paid off each year based on the available cash flow
and the required interest payments
, Finally in step 5 you make assumptions about the exit after several years usually assuming an
EBITDA Exit multiple and calculate the return based on how much equity is returned to the firm"
What variables impact a leveraged buyout the most? - ANSPurchase and exit multiples (and
therefore purchase and exit prices) have the greatest impact followed by the amount of leverage
used.
A lower purchase price equals a higher return whereas a higher exit price results in a higher
return, more leverage also results in higher returns (as long as the company can still meet its
debt obligations)
Revenue Growth, EBITDA margins, interest rates and principal repayment all make an impact
too but are less important.
How do you pick purchase multiples and exit multiples in an LBO Model? - ANSThe same way
you do it anywhere else; you look at what comparable companies are trading at, and what
multiples similar LBO transactions have been completed at. You show a range of purchases and
exit multiples using sensitivity tables.
Sometimes you set purchase and exit multiples based on a specific iRR target- this is just for
valuation purposes if you're using an LBO model to value the company.
What is an "ideal" candidate for an LBO? - ANSIdeal candidates should:
- Have stable and predictable cash flows (so they can repay debt)
- Be undervalued relative to peers in the industry (lower purchase price)
- Be low-risk businesses (debt repayments0
- Not have much need for ongoing investments such as CapEx
- Have an opportunity to cut costs and increase margins
- Have a strong management team
- Have a solid base of assets to use as collateral for debt
Stable cash flows are the most important
How do you use an LBO model to value a company, and why do we sometimes say that it sets
the "floor valuation" for the company? - ANSYou use it to value a company by setting a targeted
IRR (25% for example) and then back-solving in excel to determine what purchase price the PE
firm could pay to achieve that IRR.
This is sometimes called a "floor valuation" because PE firms almost always pay less for a
company than strategic acquirers would.
What is a leveraged buyout, and why does it work? - ANSIn a leveraged buyout (LBO), a private
equity firm acquires a company using a combination of debt and equity, operates it for several
years, possibly makes operational improvements, and then sells the company at the end of the
period to realize a return on investment.
During the period of ownership the PE firm uses the company's cash flows to pay interest
expense from the debt and to pay off debt principal.
An LBO delivers higher returns than if the PE firm used 100% cash for the following reasons:
1. By using debt, the PE firm reduces the up-front cash payment for the company, which boosts
returns
2. Using the company's cash flows to repay debt principal and pay debt interest also produces a
better return than keeping the cash flows
3. The PE firm sells the company in the future which allows it to regain the majority of the funds
spent to acquire it in the first place
Why do PE firms use leverage when buying a company? - ANSThey use leverage to increase
their returns.
Any debt raised for an LBO is not "your money" - so if you're paying $5 billion for a company its
easier to earn a high return on $2 billion of your own money and $3 billion borrowed than it is on
$5 billion of your own money.
A secondary benefit is that the firm also has more capital available to purchase other
companies.
Walk me through a basic LBO model. - ANS"In an LBO model Step 1 is making assumptions
about the purchase price, debt/equity ratio, Interest rate on debt and other variables; might also
assume something about the company's operations such as revenue growth or margins.
Step 2 is to create a sources & uses section which shows how the transaction is financed and
what the capital is used for, also tells you how much Investor Equity is required
step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figure, allocate the
purchase price, and add in Goodwill & other Intangibles on the Assets side to make everything
balance
In Step 4, you project out the company's Income Statement, balance Sheet and Cash Flow
statement and determine how much debt is paid off each year based on the available cash flow
and the required interest payments
, Finally in step 5 you make assumptions about the exit after several years usually assuming an
EBITDA Exit multiple and calculate the return based on how much equity is returned to the firm"
What variables impact a leveraged buyout the most? - ANSPurchase and exit multiples (and
therefore purchase and exit prices) have the greatest impact followed by the amount of leverage
used.
A lower purchase price equals a higher return whereas a higher exit price results in a higher
return, more leverage also results in higher returns (as long as the company can still meet its
debt obligations)
Revenue Growth, EBITDA margins, interest rates and principal repayment all make an impact
too but are less important.
How do you pick purchase multiples and exit multiples in an LBO Model? - ANSThe same way
you do it anywhere else; you look at what comparable companies are trading at, and what
multiples similar LBO transactions have been completed at. You show a range of purchases and
exit multiples using sensitivity tables.
Sometimes you set purchase and exit multiples based on a specific iRR target- this is just for
valuation purposes if you're using an LBO model to value the company.
What is an "ideal" candidate for an LBO? - ANSIdeal candidates should:
- Have stable and predictable cash flows (so they can repay debt)
- Be undervalued relative to peers in the industry (lower purchase price)
- Be low-risk businesses (debt repayments0
- Not have much need for ongoing investments such as CapEx
- Have an opportunity to cut costs and increase margins
- Have a strong management team
- Have a solid base of assets to use as collateral for debt
Stable cash flows are the most important
How do you use an LBO model to value a company, and why do we sometimes say that it sets
the "floor valuation" for the company? - ANSYou use it to value a company by setting a targeted
IRR (25% for example) and then back-solving in excel to determine what purchase price the PE
firm could pay to achieve that IRR.
This is sometimes called a "floor valuation" because PE firms almost always pay less for a
company than strategic acquirers would.
