How do private equity firms exit their position?
1) Sale to a Strategic Buyer
2) Secondary Buyout (sponsor-to-sponsor deal) - less than ideal because another PE firm won't pay a synergy premium
2) IPOs - option exclusive to firms of larger size (megafunds) or club deals
Primary Levers in ...
Wall Street Prep: LBO Fundamentals test
questions and answers
How do private equity firms exit their position? - answer 1) Sale to a Strategic Buyer
2) Secondary Buyout (sponsor-to-sponsor deal) - less than ideal because another PE firm won't
pay a synergy premium
2) IPOs - option exclusive to firms of larger size (megafunds) or club deals
Primary Levers in an LBO that drive returns? - answer 1) Deleveraging - value of equity owned
be PE firms will grow
2) EBITDA Growth - making operational improvements to teh business's margin profile,
implementing new growth strategies to increase revenue, doing add-on acquisitions that are
accretive
3) Multiple Expansion - buy at low multiple and then exit at a higher multiple
How can a company work on margin expansion? - answer 1) Build better investor sentiment
2) Better economic conditions
3) Favorable transaction dynamic (strategic rather than another sponsor)
Do PE firms typically assume entry multiple for exit? - answer It is popular to assume exit is the
same as entry - since deal environment is unknown it is too risky to assume it is higher
What attributes make a business an ideal LBO candidate? - answer 1) Steady, Predictable cash
flows
2) Strong mature industry in defensible market positioning
3) Business model with recurring revenue component
3) Strong, Committed Managment team - possible history or working with PE firms
4) Diverse revenue steams with minimal cyclicality
5) Low capex requirements and working capital needs
, 6) Currently undervalued by market (low-purchase multiple)
What industries attract the most LBO deal flow? - answer 1) Mature
2) Growing at a moderate rate
3) Non-cyclical
Predictable revenue with fewer disruption risks from technology or new entrants to having a
higher barrier entry
What will a firm look at when the investment strategy is based around roll-up acquisitions? -
answer Fragmented industries where consolidation strategy is more viable since there are more
add-on targets in the market
Ideal type of products/services being sold? - answer 1) Mission Critical - product/service is
essential to the end market being served. Discontinuity would be detrimental to business
continuity
2) High Switching Costs - costs to switch would outweight the benefits of moving to a lower-cost
provider
3) Recurring Revenue Component - products/services require MAINTENANCE
What is the typical capital structure prevalent in LBO transactions? - answer Currently around
60/40 debt to equity
Debt: They will be in different tranches with most being senior
Equity: Contribution will mostly come from the financial sponsor with in some cases an existing
management team. Also, since LBOs typically retain existing management team - sponsors will
reserve 3% - 20% of the total equity as an incentive for the management team to meet financial
targets
What credit ratios would you look at when assessing the financial health of a borrower? -
answer 1) Total Debt / EBITDA
2) Senior Debt / EBITDA
3) Net Debt / EBITDA
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