What is a leveraged buyout, and why does it work? PE firm acquires a company using a combination of Debt and Equity, operates it for several years, and then sells the company at the end of the period to realize a return on its investment.
During the period of ownership, the PE firm uses the compan...
NEW BIWS LBO TEST QUESTIONS SND
CORRECT ANSWERS
What is a leveraged buyout, and why does it work? ✅PE firm acquires a company
using a combination of
Debt and Equity, operates it for several years, and then sells the company at the end of
the period 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 Debt principal.
It works because leverage amplifies returns: If the deal performs well, the PE firm will
realize higher returns than if it had bought the company with 100% Equity.
Why do PE firms use leverage when buying companies? ✅To amplify their returns.
All PE firms aim for positive 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 up all its funds on acquiring one company.
Walk me through a basic LBO model ✅1. make assumptions for the Purchase Price,
Debt and Equity, Interest Rate on Debt, and other variables such as the company's
revenue growth and margins.
2. create a Sources & Uses schedule to show exactly how much how much in Investor
Equity the PE firm contributes; you also create a Purchase Price Allocation Schedule to
calculate the Goodwill.
3. adjust the company's Balance Sheet for the new Debt and Equity figures, allocate the
purchase price, and add Goodwill & Other Intangibles to the Assets side to make
everything balance.
4. project the company's Income Statement, Balance Sheet, and Cash Flow Statement,
and determine how much Debt it repays each year based on its Free Cash Flow.
5. make assumptions about the exit, usually assuming an EBITDA Exit Multiple, and
you calculate the IRR and Money-on-Money multiple based on the proceeds the PE firm
earns at the end."
, Can you explain the legal structure behind a leveraged buyout and how it benefits the
private equity firm? ✅In an LBO, the PE firm forms a "holding company," which it
owns, and then this "holding company" acquires the real company.
The banks and other lenders that provide the Debt lend to this Holding Company so that
the Debt is at the "HoldCo" level.
This structure is important because it means that the private equity firm is NOT "on the
hook" for the Debt it uses in the deal: It's up to the Target Company to repay it.
Not only does the PE firm borrow 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? ✅The Purchase and Exit
assumptions (usually based on EBITDA multiples) make the biggest
impact on a leveraged buyout.
A lower Purchase Multiple results in higher returns, and a higher Exit Multiple results in
higher returns.
After that, the % Debt Used 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? ✅For
public companies, typically you assume a share-price premium and check the implied
purchase multiple against the valuation methodologies to make sure it's reasonable.
For example, you might assume a 30% premium to the company's share price of
$10.00, which implies an EV / EBITDA multiple of 10x.
For private companies, you determine the purchase multiple by looking at comparable
companies, precedent transactions, and the DCF analysis.
The exit multiple is typically similar to the purchase multiple but could go higher or lower
depending on the company's FCF growth and ROIC by the end.
What is an "ideal" candidate for an LBO? ✅stable and predictable cash flows (so it can
repay Debt)
little/no need for ongoing investments such as CapEx
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