LBO

Question 1

Capital Structure - Equity

Answer 1

Question 2

What variables impact an LBO model the most?

Answer 2

1. Purchase and exit multiples
2. amount of leverage
3. operational characteristics (rev growth etc)

Question 3

Can you explain how the Balance Sheet is adjusted in an LBO model?

Answer 3

new debt is added on, and the
Shareholders’ Equity is “wiped out” and replaced by PE debt

Cash is adjusted for any cash used to finance the transaction, and
then Goodwill & Other Intangibles are used as a “plug”

Question 4

What is meant by the “tax shield” in an LBO?

Answer 4

interest a firm pays on debt is tax-deductible – so they save money
on taxes and therefore increase their cash flow as a result of having debt from the LBO

Question 5

How would a dividend recap impact the 3 financial statements in an LBO?

Answer 5

No changes to the Income Statement.

Balance Sheet, Debt would go up and
Shareholders’ Equity would go down

CFF the additional Debt raised would cancel out the Cash paid out to the investors, so Net Change in Cash would not change

Question 6

Normally we care about the IRR for the equity investors in an LBO – the PE firm
that buys the company – but how do we calculate the IRR for the debt investors?

Answer 6

you need to calculate the interest and principal payments they receive from the company each year

Question 7

Why might a private equity firm allot some of a company’s new equity in an LBO to
a management option pool, and how would this affect the model?

Answer 7

there’s no technical limit on how much management might receive
from such an option pool

In LBO, need to calculate a per-share purchase price when the PE firm exits, then calculate how much of the proceeds go to the management team based on the Treasury Stock Method

option pool by itself would reduce the PE firm’s return, but this is offset by the fact that the company should perform better with this incentive in place

Question 8

Why you would you use PIK (Payment In Kind) debt rather than other types of debt, and how does it affect the debt schedules and the other statements?

Answer 8

interest just accrues to the loan principal

Question 9

How might you estimate this Minimum Cash Balance if the company doesn’t disclose it?

Answer 9

look at Cash balance has fallen historically

look Cash as a
% of Total Expenses

Question 10

How does an Equity Rollover affect the Sources & Uses schedule in an LBO?

Answer 10

Equity Rollover reduces amount if Debt

Question 11

What does “assuming” or “refinancing” Debt mean, and how do these two options affect an LBO model?

Answer 11

Due to change of control

In LBO scenarios, PE firms must repay it with either Investor Equity (their cash) or new Debt.

1. “Assuming” Debt means that the PE firm keeps the existing Debt in place, or that it replaces it with new, identical Debt: In both cases, there’s no net impact on the Investor Equity required.
2. “Refinancing” Debt means that the PE firm repays it using Investor Equity or some combination of Investor Equity and New Debt; in these cases, more Investor Equity (and, possibly, additional Debt) is required for the deal.

Question 12

How do the transaction and financing fees factor into the LBO model?

Answer 12

The company or PE firm must pay for these fees upfront in Cash, thereby increasing the purchase price, but the accounting treatment of the fees differs.

Legal & Advisory Fees deducted friom Cash and RE

Financing Fees deducted from the carrying value of the Debt and Cash on BS

Question 13

How is Purchase Price Allocation different in LBO models? Does it matter more or less than
in M&A deals?

Answer 13

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

Question 14

How do you project Free Cash Flow and Cash Flow Available for Debt Repayment in an LBO
model?

Answer 14

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.

Question 15

How do you use a Revolver in an LBO model?

Answer 15

You draw on the Revolver when the company doesn’t have enough cash flow to meet its Mandatory Debt Repayments.

Question 16

If there’s an Equity Rollover in an LBO, could the IRR to management/existing investors ever be different than the IRR to the PE firm?

Answer 16

management/existing investors could realize a different IRR only if they rolled over their shares at a different purchase price

or something else changed their ownership

– such as
options, incentive plans, or early distributions of their proceeds.

Question 17

If a company has $10 million in revenue and $5 million in EBITDA, is it most appealing as an investment candidate if it plans to grow by selling 20% more units, raising its prices by 20%, or cutting its expenses by 20%?

Answer 17

raising prices by 20%

results in additional $2 million of EBITDA

Expense reduction of 20% will result in only $1 million of additional EBITDA

Question 18

How might a PE firm reduce its downside risk if a leveraged buyout does not perform well?

Answer 18

most risk comes from mult contraction

Best way to reduce is avoid acquiring comps that trade high

selling off non core assets would also help