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WSP- LBO graded A+
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Exam of 4 pages for the course Wall Street Prep at Wall Street Prep (WSP- LBO graded A+)
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WSP- LBOWalk me through an LBO - ANS"A leveraged buyout is a transaction where the purchase price
is funded primarily by an equity investor- which is the private equity firm also called the financial
sponsor. The remainder is funded through loans and bonds that the financial sponsor secures
ahead of the transaction. Once the sponsors gain control of the company, they get to work on
streamlining the business which usually means restructuring, layoffs, and asset sales with the
goal of making the company more efficient at generating cash flow so that the large debt burden
can be slowly paid down. The investment horizon for sponsors is 5-7 years, qt which point they
hope to be able to 'exit' by either 1) selling the company to another private equity firm or
strategic acquirer 2) taking the company public, or 3) recapitalizing the business by taking on
additional debt and issuing themselves a dividend with the debt proceeds. Accomplishing this
can provide financial sponsors with a high internal rate of return. Financial sponsors usually
target returns of 14-25% when considering making an investment. "
Walk me through an LBO model - ANS"An LBO model analyzes the impact of a company
buyout by financial sponsors using both its own equity as well as new borrowing as the two
primary sources of capital. The specific impacts analyzed by the model include an equity
valuation of the pre-LBO ""oldco"", the IRR to the various new debt and equity capital providers,
impacts on the company's financials statements and ratios. To build an LBO, start with
identifying the uses of funds- how much oldco equity will be paid any oldco debt that needs to
get refinanced, as well as any fees. Based on this, make assumptions about the sources of
funds: how much and the type of debt capital that needs to be raised, with the residual being
funded by sponsor equity. Ideally, the operations are forecasted over 5-7 years (the expected
holding period), and a complete 3-statement model is built so that the LBO debt assumptions
correctly impact the income statement and cash flow statement. In getting the correct cash flow
forecasts, it is important to build a debt schedule that accurately modifies debt based on the flow
of excess cash or deficits. Lastly, exit assumptions and the existing state of the balance sheet at
the presumed exit date, IRR, and cash on cash returns can be estimated for the sponsors (and
any debt providers as well). Lastly, scenarios and sensitivity analysis can be added to provide
users with different ways to look at the model's output- one common sensitivity is to back into
the implied oldco equity value base don explicit sponsor hurdle rates and/or operating
assumptions. "
What kind of company usually makes for a good LBO candidate? - ANS"Companies that make
good LBO candidates have steady, predictable cash flows with little cyclicality, minimal ongoing
capital expenditure, and working capital investment requirements, perhaps with subsidiary
businesses that can be immediately sold to help pay down debt. "
What ratios or metrics would you want to look at to figure out if a company is over-levered? -
ANS"I would first look at its overall capital structure and compute its Debt/Equity ratio. Since
rates of leverage that are considered acceptable can vary across industries, I would compare
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