LBO Model Questions & Answers(RATED A+)

What is an LBO? - ANSWER A leveraged buyout is the acquisition of a company using debt instruments as the majority of the purchase price. Pros: 1. Valuation is realistic as it does not require synergies to achieve. Cons: 1. Ignoring synergies could result in an underestimated valuation. 2. Very sensitive to operating (growth rate, margins, etc) and financial (multiples) assumptions. Why would you use leverage when buying a company? - ANSWER To boost the investor's return. The less of their own capital is invested, the easier it is to earn a higher return. Another benefit is that the investor also has more capital available to purchase other companies because they've used leverage. What variables impact an LBO model the most? - ANSWER 1. Purchase and exit multiples have the biggest impact on the returns of a model. 2. The amount of leverage (debt) used also has a significant impact. 3. Operational characteristics such as revenue growth and EBITDA margins. How do you pick purchase multiples and exit multiples in an LBO model? - ANSWER You look at the range of multiples for similar LBO transactions of comparable companies, and choose the multiples appropriate for your situation. Sometimes you set purchase and exit multiples based on a specific IRR target that you're trying to achieve - but 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? - ANSWER "Ideal" candidates have: 1. Stable and predictable cash flows 2. Low-risk businesses 3. Not much need for ongoing investments such as CapEx 4. Opportunities for expense reductions to boost their margins 5. A strong management team 6. A base of assets to use as collateral for debt The most important part 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? - ANSWER You use it to value a company by setting a targeted IRR (e.g., 25%) and then back-solving 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. Give an example of a "real-life" LBO. - ANSWER The most common analogy is taking out a mortgage when you buy 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 Can you explain how the Balance Sheet is adjusted in an LBO model? - ANSWER First, the Liabilities & Equities side is adjusted - the new debt is added on, and the Shareholders' Equity is "wiped out" and replaced by however much equity the private equity firm is contributing. On the Assets side, C