Walk me though a basic LBO model.
- Step 1: make assumptions about Purchase Price, Debt/Equity ratio, Interest rate on Debt, and
other variables
- Step 2: create a Sources and Uses section, showing how you finance the transaction and what
capital is used for (tells us how much Investor Equity is required)
- Step 3: adjust the company's Balance Sheet for the new Debt and Equity figures and add
Goodwill & Other Intangibles on the Assets side to make everything balance
- Step 4: project the company's Income Statement, Balance Sheet, and Cash Flow Statement,
and determine how much debt is paid off each year, based on available Cash Flow and required
Interest Payments
- Step 5: make assumptions about the exit after several years, assuming EBITDA Exit Multiple,
and calculate return based on how much equity is returned to the firm
Why would use leverage when buying a company?
- To increase your returns
- Any debt used in an LBO is not your money, so can earn a higher return using only a portion of
your own money and rest in borrowed money
- Firm also has more capital available to purchase other companies
What variable impact an LBO model the most?
- Purchase and exit multiples have biggest impact
- Amount of debt (leverage) has next most
- Operational characteristics like revenue growth or EBITDA margins have next most
How do you pick purchase multiples and exit multiples in an LBO model?
- Look at what comparable companies are trading at and what multiples similar LBO
transactions have had (show range of purchase and exit multiples using sensitivity tables)
- Sometimes set purchase and exit multiples based on specific IRR target trying to achieve
What is an "ideal" candidate for an LBO?
- "Ideal" candidates have stable and predictable cash flows, low-risk businesses, not much need
for ongoing investments like CapEx, and an opportunity for expense reductions to boost
margins
- Good management team and assets to use as collateral for debt helps
- Most important is stable cash flow
, 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?
- Value company by setting a targeted IRR (ex. 25%) and back-solving in Excel to determine
purchase price that PE firm could pay to get that IRR
- "Floor price" because PE tend to pay less for a company than strategic acquirers
Give an example of a "real-life" LBO.
- Taking out mortgage when buying a house
- Down Payment: Investor Equity
- Mortgage: Debt
- Mortgage Interest Payments: Debt Interest
- Mortgage Repayments: Debt Principal Repayments
- Selling the House: Selling the company/Taking it Public in an LBO
Can you explain how the Balance Sheet is adjusted in an LBO model?
Liabilities and Shareholders' Equity
- New debt added on, SE "wiped out" and replaced by how much equity PE firm contributes
Assets
- Cash adjusted for any cash used to finance the transaction
- Goodwill & Other Intangibles used to make Balance Sheet balance
Why are Goodwill & Other Intangibles created in an LBO?
- Ensures changes on Liabilities and Shareholders' Equity side are balanced by changes to
Assets side
We saw that a strategic acquirer will usually prefer to pay for another company in cash - if that's
the case, why would a PE firm want to use debt in an LBO?
- PE firms doesn't intend to hold company for long-term (will sell after a few years so less
concerned about "expense" of cash vs. debt and more with using leverage to boost returns by
reducing amount of its own capital it uses)
- Debt is less risky because the debt is "owned" by the company the PE firm buys so the
company assumes much of the risk (in strategic acquisition, buyer "owns" the debt so more
risky for buyer
Do you need to project all 3 statements in an LBO model? Are there any shortcuts?
- Don't need to project all 3, there are shortcuts
- Full Balance Sheet not required because you can make assumptions on Net Change in
Working Capital
- Step 1: make assumptions about Purchase Price, Debt/Equity ratio, Interest rate on Debt, and
other variables
- Step 2: create a Sources and Uses section, showing how you finance the transaction and what
capital is used for (tells us how much Investor Equity is required)
- Step 3: adjust the company's Balance Sheet for the new Debt and Equity figures and add
Goodwill & Other Intangibles on the Assets side to make everything balance
- Step 4: project the company's Income Statement, Balance Sheet, and Cash Flow Statement,
and determine how much debt is paid off each year, based on available Cash Flow and required
Interest Payments
- Step 5: make assumptions about the exit after several years, assuming EBITDA Exit Multiple,
and calculate return based on how much equity is returned to the firm
Why would use leverage when buying a company?
- To increase your returns
- Any debt used in an LBO is not your money, so can earn a higher return using only a portion of
your own money and rest in borrowed money
- Firm also has more capital available to purchase other companies
What variable impact an LBO model the most?
- Purchase and exit multiples have biggest impact
- Amount of debt (leverage) has next most
- Operational characteristics like revenue growth or EBITDA margins have next most
How do you pick purchase multiples and exit multiples in an LBO model?
- Look at what comparable companies are trading at and what multiples similar LBO
transactions have had (show range of purchase and exit multiples using sensitivity tables)
- Sometimes set purchase and exit multiples based on specific IRR target trying to achieve
What is an "ideal" candidate for an LBO?
- "Ideal" candidates have stable and predictable cash flows, low-risk businesses, not much need
for ongoing investments like CapEx, and an opportunity for expense reductions to boost
margins
- Good management team and assets to use as collateral for debt helps
- Most important is stable cash flow
, 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?
- Value company by setting a targeted IRR (ex. 25%) and back-solving in Excel to determine
purchase price that PE firm could pay to get that IRR
- "Floor price" because PE tend to pay less for a company than strategic acquirers
Give an example of a "real-life" LBO.
- Taking out mortgage when buying a house
- Down Payment: Investor Equity
- Mortgage: Debt
- Mortgage Interest Payments: Debt Interest
- Mortgage Repayments: Debt Principal Repayments
- Selling the House: Selling the company/Taking it Public in an LBO
Can you explain how the Balance Sheet is adjusted in an LBO model?
Liabilities and Shareholders' Equity
- New debt added on, SE "wiped out" and replaced by how much equity PE firm contributes
Assets
- Cash adjusted for any cash used to finance the transaction
- Goodwill & Other Intangibles used to make Balance Sheet balance
Why are Goodwill & Other Intangibles created in an LBO?
- Ensures changes on Liabilities and Shareholders' Equity side are balanced by changes to
Assets side
We saw that a strategic acquirer will usually prefer to pay for another company in cash - if that's
the case, why would a PE firm want to use debt in an LBO?
- PE firms doesn't intend to hold company for long-term (will sell after a few years so less
concerned about "expense" of cash vs. debt and more with using leverage to boost returns by
reducing amount of its own capital it uses)
- Debt is less risky because the debt is "owned" by the company the PE firm buys so the
company assumes much of the risk (in strategic acquisition, buyer "owns" the debt so more
risky for buyer
Do you need to project all 3 statements in an LBO model? Are there any shortcuts?
- Don't need to project all 3, there are shortcuts
- Full Balance Sheet not required because you can make assumptions on Net Change in
Working Capital
