Leveraged Buyouts and LBO Models - Exit Strategies Questions and Correct Answers
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Module
LBO Modeling
Institution
LBO Modeling
1. What are the different exit strategies available to a private equity firm in a leveraged buyout, and what are the advantages and disadvantages of each one? The main exit strategies are an M&A deal, an initial public offering (IPO), and a dividend recapitalization.
In an M&A Deal, the PE firm se...
Leveraged Buyouts and LBO Models -
Exit Strategies Questions and Correct
Answers
1. What are the different exit strategies available to a private equity firm in a leveraged
buyout, and what are the advantages and disadvantages of each one? ✅The main exit
strategies are an M&A deal, an initial public offering (IPO), and a dividend
recapitalization.
In an M&A Deal, the PE firm sells the company to another company or PE firm. It's a
clean and simple break where the firm earns all the deal proceeds in one fell swoop.
In an IPO Exit, the PE firm takes the company public and sells off its shares gradually
over time; sometimes companies that can't be acquired can go public, which is the main
advantage.
But the disadvantage is that the sale of the PE firm's stake takes much longer, so
there's also more risk (e.g., if the company's share price drops). The firm can't sell its
entire stake all at once because it sends a negative signal to other investors.
In a Dividend Recapitalization, the company issues Dividends to the PE firm continually
or takes on additional Debt to issue Dividends, and the PE firm earns the deal proceeds
gradually over time.
It is very tough to earn an acceptable IRR with the Dividend Recap, but sometimes it is
the only option if the M&A or IPO markets are underdeveloped or the company has
legal or PR issues that prevent it from using those strategies.
2. What IRR and MoM multiple do PE firms typically target? ✅Most private equity firms
aim for an IRR of at least 20%, about twice what public equity markets in developed
countries have returned historically.
The targeted multiple depends on the time frame of each investment, but a 20% IRR
over 5 years equates to a 2.5x multiple, so many firms target at least that much.
If the firm holds companies for longer periods - say, 7 years on average - then it may
need to target a higher multiple, such as 3.5x (a ~20% IRR over 7 years).
Most firms also target different numbers for Base, Upside, and Downside cases, and
aim to avoid losing money no matter what happens.
3. Would you rather achieve a high IRR or a high MoM multiple in a leveraged buyout?
✅It's completely dependent on the time frame. Over a short period, such as 6 months,
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