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LBO Model - Advanced already graded A+
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LBO Model - Advanced already graded A+
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LBO Model - AdvancedHow would an asset write-up or write-down affect an LBO model? / Walk me through how you
adjust the Balance Sheet in an LBO model. - ANSAll of this is very similar to what you would
see in a merger model - you calculate Goodwill, Other Intangibles, and the rest of the write-ups
in the same way, and then the Balance Sheet adjustments (e.g. subtracting cash, adding in
capitalized financing fees, writing up assets, wiping out goodwill, adjusting the deferred tax
assets / liabilities, adding in new debt, etc.) are almost the same.
The key differences:
• In an LBO model you assume that the existing Shareholders' Equity is wiped out and replaced
by the equity the private equity firm contributes to buy the company; you may also add in
Preferred Stock, Management Rollover, or Rollover from Option Holders to this number as well
depending on what you're
assuming for transaction financing.
• In an LBO model you'll usually be adding a lot more tranches of debt vs. what
you would see in a merger model.
• In an LBO model you're not combining two companies' Balance Sheets.
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? - ANSFor the debt investors,
you need to calculate the interest and principal payments they receive from the company each
year.
Then you simply use the IRR function in Excel and start with the negative amount of the original
debt for "Year 0," assume that the interest and principal payments each year are your "cash
flows" and then assume that the remaining debt balance in the final year is your "exit value."
Most of the time, returns for debt investors will be lower than returns for the equity investors -
but if the deal goes poorly or the PE firm can't sell the company for a good price, the reverse
could easily be true.
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? - ANSThis is done for the same
reason you have an Earnout in an M&A deal: the PE firm wants to incentivize the management
team and keep everyone on-board until they exit the investment.
The difference is that there's no technical limit on how much management might receive from
such an option pool: if they hit it out of the park, maybe they'll all become millionaires.
, In your LBO model, you would need to calculate a per-share purchase price when the PE firm
exits the investment, and then calculate how much of the proceeds go to the management team
based on the Treasury Stock Method.
An 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.
Why would you use PIK (Payment In Kind) debt rather than other types of debt, and how does it
affect the debt schedules and other statements? - ANSUnlike "normal" debt, a PIK loan does
not require the borrower to make cash interest payments - instead, the interest just accrues to
the loan principal, which keeps going up over time. A PIK "toggle" allows the company to
choose whether to pay the interest in cash or have it accrue to the principal (these have
disappeared since the credit crunch).
PIK is more risky than other forms of debt and carries with it a higher interest rate than
traditional bank debt or high yield debt.
Adding it to the debt schedules is similar to adding high-yield debt with a bullet maturity - except
instead of assuming cash interest payments, you assume that the interest accrues to the
principal instead.
You should then include this interest on the Income Statement, but you need to add back any
PIK interest on the Cash Flow Statement because it's a non-cash expense.
What are some examples of incurrence covenants? Maintenance covenants? - ANSIncurrence
Covenants:
• Company cannot take on more than $2 billion of total debt.
• Proceeds from any asset sales must be earmarked to repay debt.
• Company cannot make acquisitions of over $200 million in size.
• Company cannot spend more than $100 million on CapEx each year.
Maintenance Covenants:
• Total Debt / EBITDA cannot exceed 3.0 x
• Senior Debt / EBITDA cannot exceed 2.0 x
• (Total Cash Payable Debt + Capitalized Leases) / EBITDAR cannot exceed 4.0 x
• EBITDA / Interest Expense cannot fall below 5.0 x
• EBITDA / Cash Interest Expense cannot fall below 3.0 x
• (EBITDA - CapEx) / Interest Expense cannot fall below 2.0 x
Just like a normal M&A deal, you can structure an LBO either as a stock purchase or as an
asset purchase. Can you also use Section 338(h)(10) election? - ANSIn most cases, no -
because one of the requirements for Section 338(h)(10) is that the buyer must be a C
corporation. Most private equity firms are organized as LLCs or Limited Partnerships, and when
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