LBO Questions and Answers
1. A strategic acquirer usually prefers to pay for another company with 100% cash - if that's
the case, why would a PE firm want to use debt in an LBO? - ANS-It's a different
scenario because:
1. The PE firm does not hold the company for the long-term - it sells it after a few
years, so it is less concerned with the higher "expense" of debt over cash and is
more concerned about using leverage to boost its returns by
reducing the capital it contributes upfront.
2. In an LBO, the company is responsible for repaying the debt, so the company
assumes much of the risk. Whereas in a strategic acquisition, the buyer "owns"
the debt, so it is more risky for them.
2. Bank Debt vs. High Yield Debt - ANS--high yield debt tends to have higher interest
rates than bank debt
-high yield debt interest rates are usually fixed, whereas bank debt interest rates
on floating...they change based on fed interest rate
-high yield debt has incurrence covenants(prevent you from doing something
such as buying factory) while bank debt has maintenance covenants which
require you to maintain a minimal financial performance.
-bank debt is usually amortized-principal must be paid off over time whereas high
yield debt entire principal is due at the end (bullet)
3. Changes That Increase IRR - ANS-Lower Purchase Price, Less Equity, Higher
Revenue Growth, Higher EBITDA Margins, Lower Interest Rates, Lower CapEx
4. Changes That Reduce IRR: - ANS-Higher Purchase Price, More Equity, Lower
Revenue Growth, Lower EBITDA Margins, Higher Interest Rates, Higher CapEx
5. Give me an example of a "real-life" LBO. - ANS-"Buying a house that you rent out to
other people:
Down Payment: Investor Equity in an LBO
Mortgage: Debt in an LBO
Mortgage Interest Payments: Debt Interest in an LBO
Mortgage Repayments: Debt Principal Repayments in an LBO
Rental Income from Tenants: Cash Flow to Pay Interest and Repay Debt in an LBO
Selling the House: Selling the Company or Taking It Public in an LBO
6. How could a private equity firm boost its return in an LBO? - ANS-1. Reduce the
Purchase Price.
2. Increase the Exit Multiple and Exit Price.
3. Increase the Leverage (debt) used.
4. Increase the company's growth rate (organically or via acquisitions).
5. Increase margins by reducing expenses (cutting employees, consolidating
buildings, etc.).
These are all "theoretical"
1. A strategic acquirer usually prefers to pay for another company with 100% cash - if that's
the case, why would a PE firm want to use debt in an LBO? - ANS-It's a different
scenario because:
1. The PE firm does not hold the company for the long-term - it sells it after a few
years, so it is less concerned with the higher "expense" of debt over cash and is
more concerned about using leverage to boost its returns by
reducing the capital it contributes upfront.
2. In an LBO, the company is responsible for repaying the debt, so the company
assumes much of the risk. Whereas in a strategic acquisition, the buyer "owns"
the debt, so it is more risky for them.
2. Bank Debt vs. High Yield Debt - ANS--high yield debt tends to have higher interest
rates than bank debt
-high yield debt interest rates are usually fixed, whereas bank debt interest rates
on floating...they change based on fed interest rate
-high yield debt has incurrence covenants(prevent you from doing something
such as buying factory) while bank debt has maintenance covenants which
require you to maintain a minimal financial performance.
-bank debt is usually amortized-principal must be paid off over time whereas high
yield debt entire principal is due at the end (bullet)
3. Changes That Increase IRR - ANS-Lower Purchase Price, Less Equity, Higher
Revenue Growth, Higher EBITDA Margins, Lower Interest Rates, Lower CapEx
4. Changes That Reduce IRR: - ANS-Higher Purchase Price, More Equity, Lower
Revenue Growth, Lower EBITDA Margins, Higher Interest Rates, Higher CapEx
5. Give me an example of a "real-life" LBO. - ANS-"Buying a house that you rent out to
other people:
Down Payment: Investor Equity in an LBO
Mortgage: Debt in an LBO
Mortgage Interest Payments: Debt Interest in an LBO
Mortgage Repayments: Debt Principal Repayments in an LBO
Rental Income from Tenants: Cash Flow to Pay Interest and Repay Debt in an LBO
Selling the House: Selling the Company or Taking It Public in an LBO
6. How could a private equity firm boost its return in an LBO? - ANS-1. Reduce the
Purchase Price.
2. Increase the Exit Multiple and Exit Price.
3. Increase the Leverage (debt) used.
4. Increase the company's growth rate (organically or via acquisitions).
5. Increase margins by reducing expenses (cutting employees, consolidating
buildings, etc.).
These are all "theoretical"
