Exam (elaborations)
WSP- LBO QUESTIONS AND ANSWERS 2023/2024
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WSP- LBO QUESTIONS AND ANSWERS 2023/2024
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WSP- LBOWalk me through an LBOANSWER"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 modelANSWER"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?ANSWER"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. "
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