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Leveraged Buyouts and LBO Models 2023/2024 already graded A+
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Leveraged Buyouts and LBO ModelsWhat is a leveraged buyout and why does it work? - ANSIn a leveraged buyout (LBO), a private
equity firm acquiresd a company using a combination of debt and equity, operaites it for several
years, and then sells the company at the end of the periof to realize a return on its investment.
During the period of ownership, the PE firm uses the company's cash flows to pay for the
interest expense on the debt and to repay the debt principal.
It works because leveraged AMPLIES returns: if the deal performs well, the PE firm will realize
higher returns than if it has bought the company with 100% equity.
But leverage also presents risks because it means the returns will be even worse if the deal
does NOT perform well.
Why do PE firms use leveraged when buying companies? - ANSTo AMPLIFY their returns, it
does NOT "increase returns" - using leveraged - borrowing money from others - to fund a deal
simply makes positive returns more positive and negative returns more negative.
All PE firms aim for poisitve returns above a certain IRR and using leverage makes it easier to
get there ... if the deal goes well.
A secondary benefit is that the PE firm has more capital available to buy other companies since
it won't use uup all of its funds on acquiring one company.
Walk me through a basic LBO - ANSIn an LBO model, in Step 1, you make assumptions for the
purchase pricem debt, and ewuity, interest rate on debt, and other variables such as the
company's revenue an growth amrgins.
In step 2, you create a soruces and uses schedule to show exacty how much in investor equity
the PE firm contributes, you also create a purchase price allocation schedule to calculate the
goodwill.
In step 3, you adjust the company's balance sheet for the new debt and ewuiy figures, allocate
the purchase price, and add the good will and other intangibles to the assets side to maker
everything balance.
In step 4, you project the company's income statement, balance sheet, and cash flow statement,
and detemrine how much debt ir repays each year based on its FCF.
, In step 5, you make assumpttions about the exit, usually assuming an EBITDA exit multiole, and
you calulate the IRR and the money-on-money multiple based on the priceeds the PE firms
earns at the end.
Can you explain the legal structure behind a leveraged buyout and how it benefits the PE firm? -
ANSIn a leveraged buyout, the PE firms forms a "holding company" which it owns, and then this
"holding company" acquires the real company.
The banks and other lends provide the debt lend to this holding company so that the debt is at
the "HoldCo" level.
Managers and executives at the acquired company that retain owernshio after the deal closes
also have shares in this holding company.
The structure is important beause it means that the private equity firm is NOT "on the book" for
the debt it uses in the deal: it's up to the target comapny to repay it.
Not only does the PE firm birriw other peoples' money to do the deal, but it doesn't even borrow
the money directly - the company borrows the money so the PE firm can do the deal.
What assumptions impact a leveraged buyout the most? - ANSThe pruchase price and exit
assumptionsm usually based on the EBITDA multiple, make the biggest impact on a leveraged
buyout.
A lower pruchase multiple results in hgiher returns, and a higher exit multiple results in higher
returns.
After that, the % debt used to makes the biggest impact. If the deal performs well, more
leverage will make it perform even better, and vice versa if it does not perform well.
Revenue growth, EBITDA margins, interest rates, and principal repayments on debt all make an
impact as well, but less so than the other assumptions.
How do you select the purchase multiples and exit multiples in an LBO model? - ANSFor public
companis, typicaly you assume a shre-porice premium and check the implied purchase multiple
against the valuation methodologies to make sure it's reasonable.
For private companies,m you determine the pruchase multiple by looking at comparable
companes, precdent tarnsactions, and the DCF analysis.
The exit multiple is typically similar to the purchase multiple but could go hgiher or lower
depending on the company's FCF and ROIC by the end.
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