LBO Modelling Exam Questions & Answers
What is the biggest difference Unlike an M&A, we're not assuming the PE firm will keep the
between an LBO and an company long term
M&A?
-opportunity to cut costs
-stable cash flows
What makes a good LBO
-good base of assets
candidate?
-undervalued/low-risk
1. Make assumptions about the Purchase Price and how much debt
to use
2. Create a Financial Sources & Uses section
Walk me through a basic LBO 3. Adjust the company's Balance Sheet
model.
4. Project the company's statements and determine how
much debt you can pay off each year
5. Calculate the IRR and an EBITDA exit multiple
Why do you focus on Equity You need to acquire all the outstanding shares of a public
value in an LBO? company
-Bank debt (Revolver, Term Loan A/B): Lower, floating
interest rates, annual principal repayments,
maintenance covenants (i.e. Total Debt/EBITDA must
What is Bank Debt vs. High- be below 4x),
Yield Debt? secured (collatoralized), allows prepayment
-High-yield debt (Senior/Subordinate notes, Mezzanine):
Higher, fixed interest rates, no annual repayments,
incurrence covenants (i.e. the company can't acquire
another and sell off assets), not secured, doesn't
allow prepayment
-Don't want the risk of floating rates
Why might a PE firm prefer -Intend to refinance the debt
High-Yield Debt? -Aren't planning big expansions
-Don't believe their returns are sensitive to interest payments
You can look at recent, similar LBOs and assess the
How to assess the amount of terms, or you can look at your company's Leverage
debt to use:
Ratio or Interest Coverage ratio, to see how much
debt it can afford to take on.
Leverage Ratio = Debt / EBITDA
, Interest coverage ratio EBITDA / Interest Expense
Debt/EBITDA should rarely exceed 10x.
What are reasonable
Leverage and Coverage For Interest Coverage, you want a number where the company
can pay for its
Ratios?
interest without trouble, but also not high enough where it can't
afford more debt.
The returns go up because reducing the amount of
Why is it better to reduce the
cash you pay up-front for an asset has a
amount of cash PE firms
disproportionate effect on your returns... since money
pay up front?
today is worth more than money tomorrow.
-Buyout of oldco's equity
Common Uses of Funding -Refinancing of oldco debt
-Transaction & Financing fees
-Excess cash
-Debt (term loans, notes, etc.)
Common Sources of Funding -Preferred stock
-Management rollover
-Sponsor equity
Do you pay the Equity Value -If you refinance existing debt, the price will be closer to the
or Enterprise Value in an Enterprise Value
-if you assume the debt, the purchase price will be closer to the
LBO?
Equity value
What happens if the PE firm The PE firm must increase the funds required to buy
pays off the debt? the company, and the debt goes under the uses
column (purchase price is closer to the EV)
It has no impact on the total funds it must raise, and it
What happens if the PE firm
goes on the balance sheet of the PE firm and listed
assumes (takes on) the
under both sources and uses (purchase price closer
debt?
to the Equity Value)
How do you project how 1. Calculate the LBO FCF
much debt you can pay off 2. Set mandatory debt repayments and use any
each year after projecting leftover FCF to make optional payments
the Income Statement?
-the company's minimum cash balance
What are some factors to
-if the debt can be paid off early
consider when determining
-if company has enough FCF for the minimum repayments (may
how much debt can be need to borrow from
paid off using FCF's? revolver)
LBO FCF's = CFO - CapEx
What is the biggest difference Unlike an M&A, we're not assuming the PE firm will keep the
between an LBO and an company long term
M&A?
-opportunity to cut costs
-stable cash flows
What makes a good LBO
-good base of assets
candidate?
-undervalued/low-risk
1. Make assumptions about the Purchase Price and how much debt
to use
2. Create a Financial Sources & Uses section
Walk me through a basic LBO 3. Adjust the company's Balance Sheet
model.
4. Project the company's statements and determine how
much debt you can pay off each year
5. Calculate the IRR and an EBITDA exit multiple
Why do you focus on Equity You need to acquire all the outstanding shares of a public
value in an LBO? company
-Bank debt (Revolver, Term Loan A/B): Lower, floating
interest rates, annual principal repayments,
maintenance covenants (i.e. Total Debt/EBITDA must
What is Bank Debt vs. High- be below 4x),
Yield Debt? secured (collatoralized), allows prepayment
-High-yield debt (Senior/Subordinate notes, Mezzanine):
Higher, fixed interest rates, no annual repayments,
incurrence covenants (i.e. the company can't acquire
another and sell off assets), not secured, doesn't
allow prepayment
-Don't want the risk of floating rates
Why might a PE firm prefer -Intend to refinance the debt
High-Yield Debt? -Aren't planning big expansions
-Don't believe their returns are sensitive to interest payments
You can look at recent, similar LBOs and assess the
How to assess the amount of terms, or you can look at your company's Leverage
debt to use:
Ratio or Interest Coverage ratio, to see how much
debt it can afford to take on.
Leverage Ratio = Debt / EBITDA
, Interest coverage ratio EBITDA / Interest Expense
Debt/EBITDA should rarely exceed 10x.
What are reasonable
Leverage and Coverage For Interest Coverage, you want a number where the company
can pay for its
Ratios?
interest without trouble, but also not high enough where it can't
afford more debt.
The returns go up because reducing the amount of
Why is it better to reduce the
cash you pay up-front for an asset has a
amount of cash PE firms
disproportionate effect on your returns... since money
pay up front?
today is worth more than money tomorrow.
-Buyout of oldco's equity
Common Uses of Funding -Refinancing of oldco debt
-Transaction & Financing fees
-Excess cash
-Debt (term loans, notes, etc.)
Common Sources of Funding -Preferred stock
-Management rollover
-Sponsor equity
Do you pay the Equity Value -If you refinance existing debt, the price will be closer to the
or Enterprise Value in an Enterprise Value
-if you assume the debt, the purchase price will be closer to the
LBO?
Equity value
What happens if the PE firm The PE firm must increase the funds required to buy
pays off the debt? the company, and the debt goes under the uses
column (purchase price is closer to the EV)
It has no impact on the total funds it must raise, and it
What happens if the PE firm
goes on the balance sheet of the PE firm and listed
assumes (takes on) the
under both sources and uses (purchase price closer
debt?
to the Equity Value)
How do you project how 1. Calculate the LBO FCF
much debt you can pay off 2. Set mandatory debt repayments and use any
each year after projecting leftover FCF to make optional payments
the Income Statement?
-the company's minimum cash balance
What are some factors to
-if the debt can be paid off early
consider when determining
-if company has enough FCF for the minimum repayments (may
how much debt can be need to borrow from
paid off using FCF's? revolver)
LBO FCF's = CFO - CapEx
