Paper LBO

Question 1

IRR MOM Conversion

Answer 1

Question 2

Parameter Value
EBITDA (flat) €80m
Entry Debt/EBITDA 4.0×
Holding Period 5 years
Exit Multiple 9.0×
Target MoM 2.5× (on equity)
No debt amortization Entire debt remains outstanding

Answer 2

Question 3

How does applying a mid-year convention affect EV in a DCF or exit proceeds in an LBO?

Answer 3

MYC increases EV slightly by discounting cash flows as if they are received throughout the year

reflects earlier receipt of cash and results in a higher present value.

Question 4

How would replacing TLB with TLA affect IRR and cash flows?

Answer 4

TLA requires amortization → reduces cash available to equity → lower IRR. But it lowers credit risk and interest cost.

TLB is more IRR-friendly (bullet maturity) but more expensive.

Question 5

How does a mid-hold refinancing at lower spread affect returns?

Answer 5

Reduces interest expense → boosts FCF → allows faster debt paydown or equity dividends → improves IRR.

Timing and transaction costs also matter.

Question 6

If 50% of excess cash is swept to repay debt each year, how does it affect IRR?

Answer 6

Only if voluntary and else cash would be idle!!!!

Accelerates debt paydown → reduces interest cost → increases equity value at exit → usually increases IRR, especially in cash-generative businesses.

Question 7

At what exit multiple does the sponsor break even? At what EBITDA?

Answer 7

Depends on entry EV, leverage, and hold period. Breakeven multiple is when exit equity = entry equity.

Requires sensitivity analysis in LBO model.

Question 8

How does a PIK toggle affect free cash flow and IRR?

Answer 8

Defers cash interest → boosts FCF in early years → improves IRR.

But increases total debt burden and interest compounding → may reduce equity proceeds if exit value doesn’t grow.

Question 9

How does a 20% management rollover impact sponsor IRR?

Answer 9

Sponsor invests less equity → higher leverage on their portion → boosts IRR if returns are strong.

Total deal IRR unchanged; sponsor IRR benefits due to lower capital invested.

Question 10

Would an asset-light business lead to higher IRR? Why?

Answer 10

Yes, typically. Asset-light businesses require less capex and working capital → more FCF → higher debt capacity → greater equity returns.

Question 11

If NWC grows faster than revenue, what happens to cash flow and return?

Answer 11

Ties up more cash in operations → reduces FCF → slows debt paydown → reduces IRR. Watch for seasonal or structural changes in NWC needs.

Question 12

What is Managment Rollover

Answer 12

In a leveraged buyout (LBO), management rollover means that part of the target company’s management team reinvests their own equity into the new capital structure instead of cashing out entirely.

Question 13

How Does Rollover Improve Leverage and IRR?

Answer 13

1. Improves Leverage:
   → Management’s equity reduces the sponsor’s equity requirement.

→ The same enterprise value is achieved with less sponsor capital, hence more debt proportionally.

2. Boosts IRR:
   → Less sponsor equity → higher return on invested capital.

→ IRR is calculated on the sponsor’s invested equity only.

→ Rollover acts like co-investment, not a cost.

Question 14

Would using more debt always increase IRR? Why or why not?

Answer 14

Not always. While more debt reduces the sponsor’s equity and may increase IRR, too much leverage increases financial risk, interest expense, and bankruptcy probability.

Diminishing returns occur when cash flow can’t cover debt service or covenants are breached.

Question 15

Why do investment banks build LBO models for strategic buyers?

Answer 15

The LBO provides a “floor valuation” based on the return a financial buyer would require (e.g., 20% IRR). It shows what a sponsor could afford to pay and informs valuation in auctions.

Question 16

What does covenant-lite debt mean for LBO modeling or downside risk?

Answer 16

Fewer lender protections → more flexibility for sponsor but higher downside risk for lenders. Less trigger for early restructuring, but riskier in downturns.

Question 17

A company has negative working capital. What is the FCF impact?

Answer 17

It’s positive for FCF. Negative working capital means customers pay before suppliers are paid (e.g., retail). Generates cash as the company grows.

Question 18

In the context of an LBO, what is the “tax shield”?

Answer 18

“tax shield” refers to the reduction in taxable income from the highly levered capital structure.

As interest payments on debt are tax-deductible, the tax savings provide an additional incentive for private
equity firms to maximize the amount of leverage they can get for their transactions

Question 19

Can you name a scenario when multiple contraction is common?

Answer 19

For large-sized companies undergoing LBOs, it’s normal to see minor multiple contractions.

The reason is that
as the company grows larger, the number of potential bidders that could afford to purchase the company grows
smaller (i.e., a reduced pool of prospective buyers with sufficient capital)

Question 20

Rule of 72

Answer 20

Dividide 72 by annual return to get the number of years it would take to double

Question 21

What is a distribution waterfall schedule in private equity?

Answer 21

Classic PE Distribution Waterfall:

1. The initial investment from the LPs will first be returned in full, along with any returns related to a fund’s
   pre-determined minimum hurdle rate.
2. Then, 20% of the returns will be distributed to the GPs due to the catch-up clause.
3. The remaining excess proceeds would then be split 80% to the LP and 20% to the GP. The percentages
   can vary, but the 80/20 split is the industry standard.

Question 22

What levers have a positive/negative impact on the IRR of an investment?

Answer 22

Question 23

How does the accounting treatment of financing fees differ from transaction fees in an LBO?

Answer 23

Financing Fees: Financing fees are related to raising debt or issuing equity. These fees are capitalized and
amortized over the debt’s maturity (~5-7 years).

Transaction Fees: Transaction fees refer to the M&A advisory fees paid to investment banks or business
brokers, as well as the legal fees paid to lawyers. Unlike financing fees, transaction fees cannot be
amortized and are classified as one-time expenses deducted from a company’s retained earnings.