7.4 Leveraged Buyouts and LBO Models - Financial
Statement and Debt Projections (real exam quizzes
with correct detailed answers)
The adjustments are similar to those in an M&A deal, but in an LBO, you don't "combine" the
Seller's Balance Sheet with the Buyer's since the "Buyer" is an empty shell corporation.
You still write down the company's Shareholders' Equity and replace it with the Investor Equity
the PE firm is contributing, you still create Goodwill and Other Intangible Assets, and you might
adjust the Deferred Tax-related items as well.
You also add the new Debt and possibly adjust the existing Debt on the L&E side of the Balance
Sheet; you adjust Cash on the Assets side for deal funding and transaction fees. You may also
write up or down Asset values.
You deduct one-time Transaction Fees from Retained Earnings and Financing Fees from the
book value of the new Debt issued. - answers✔✔1. Can you explain how to adjust the Balance
Sheet in an LBO model?
It's the same process as in M&A deals, but it tends to matter far less because leveraged buyouts
are based on cash flow, Debt repayment, and the IRR from acquiring and then selling a
company.
Many of the new items that get created in the PPA process, such as D&A on Asset Write-Ups,
affect the company's EPS but barely make an impact on its cash flow, which is why many LBO
, models leave out this schedule. - answers✔✔2. How is Purchase Price Allocation different in
LBO models? Does it matter more or less than in M&A deals?
You start with Net Income, add back D&A, factor in the Change in Working Capital, and subtract
CapEx to determine a company's FCF in a leveraged buyout.
You should not add back Stock-Based Compensation because it creates additional shares,
reducing the PE firm's ownership in the company; it's easier to treat SBC as a cash expense.
You might factor in other items such as Deferred Taxes, but these should not make a huge
difference for FCF.
Cash Flow Available for Debt Repayment is similar to FCF, but also adds the company's
Beginning Cash Balance and subtracts its Minimum Cash Balance and other obligations such as
repayments of assumed Debt. - answers✔✔3. How do you project Free Cash Flow and Cash
Flow Available for Debt Repayment in an LBO model?
First, the purpose is quite different since FCF in an LBO model determines a company's ability to
repay Debt, not the implied value of the entire company.
Second, FCF in an LBO model starts with Net Income, not NOPAT, and so it includes the Net
Interest Expense. But it's also not Levered FCF since it does not include Debt principal
repayments.
Finally, while FCF is the end point in a DCF, you have to go beyond it in an LBO model because of
the company's Beginning Cash Balance, Minimum Cash, and, potentially, other obligations such
as repayments of Existing Debt. - answers✔✔4. How is the "Free Cash Flow" in an LBO model
different from the FCF in a DCF?
It might differ because of the additional components that go into Cash Flow Available for Debt
Repayment: The Beginning Cash, Minimum Cash, and Other Obligations.
Statement and Debt Projections (real exam quizzes
with correct detailed answers)
The adjustments are similar to those in an M&A deal, but in an LBO, you don't "combine" the
Seller's Balance Sheet with the Buyer's since the "Buyer" is an empty shell corporation.
You still write down the company's Shareholders' Equity and replace it with the Investor Equity
the PE firm is contributing, you still create Goodwill and Other Intangible Assets, and you might
adjust the Deferred Tax-related items as well.
You also add the new Debt and possibly adjust the existing Debt on the L&E side of the Balance
Sheet; you adjust Cash on the Assets side for deal funding and transaction fees. You may also
write up or down Asset values.
You deduct one-time Transaction Fees from Retained Earnings and Financing Fees from the
book value of the new Debt issued. - answers✔✔1. Can you explain how to adjust the Balance
Sheet in an LBO model?
It's the same process as in M&A deals, but it tends to matter far less because leveraged buyouts
are based on cash flow, Debt repayment, and the IRR from acquiring and then selling a
company.
Many of the new items that get created in the PPA process, such as D&A on Asset Write-Ups,
affect the company's EPS but barely make an impact on its cash flow, which is why many LBO
, models leave out this schedule. - answers✔✔2. How is Purchase Price Allocation different in
LBO models? Does it matter more or less than in M&A deals?
You start with Net Income, add back D&A, factor in the Change in Working Capital, and subtract
CapEx to determine a company's FCF in a leveraged buyout.
You should not add back Stock-Based Compensation because it creates additional shares,
reducing the PE firm's ownership in the company; it's easier to treat SBC as a cash expense.
You might factor in other items such as Deferred Taxes, but these should not make a huge
difference for FCF.
Cash Flow Available for Debt Repayment is similar to FCF, but also adds the company's
Beginning Cash Balance and subtracts its Minimum Cash Balance and other obligations such as
repayments of assumed Debt. - answers✔✔3. How do you project Free Cash Flow and Cash
Flow Available for Debt Repayment in an LBO model?
First, the purpose is quite different since FCF in an LBO model determines a company's ability to
repay Debt, not the implied value of the entire company.
Second, FCF in an LBO model starts with Net Income, not NOPAT, and so it includes the Net
Interest Expense. But it's also not Levered FCF since it does not include Debt principal
repayments.
Finally, while FCF is the end point in a DCF, you have to go beyond it in an LBO model because of
the company's Beginning Cash Balance, Minimum Cash, and, potentially, other obligations such
as repayments of Existing Debt. - answers✔✔4. How is the "Free Cash Flow" in an LBO model
different from the FCF in a DCF?
It might differ because of the additional components that go into Cash Flow Available for Debt
Repayment: The Beginning Cash, Minimum Cash, and Other Obligations.
