Investment Banking Set- Leveraged Buyout (LBO) Questions and Correct Answers
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Course
LBO Modeling
Institution
LBO Modeling
Leveraged Buyout - LBO • An LBO is an acquisition of a target using primarily debt to finance the purchase
• You buy a company using leverage, pay down debt with FCF and then hope to sell it later at a higher EBITDA multiple
• Debt can be 60-70% of purchase price
• LBOs can generate inve...
Investment Banking Set- Leveraged
Buyout (LBO) Questions and Correct
Answers
Leveraged Buyout - LBO ✅• An LBO is an acquisition of a target using primarily debt
to finance the purchase
• You buy a company using leverage, pay down debt with FCF and then hope to sell it
later at a higher EBITDA multiple
• Debt can be 60-70% of purchase price
• LBOs can generate investor returns in two ways (or a combination of the two): debt
repayment and growth in enterprise value
• Why use debt? In order to boost returns - leverage amplifies returns
o Ex. $200,000 to $220,000 would earn 10% cash return, but someone who paid
$40,000 in cash while borrowing $160,000 would earn 50% cash return as the house
rose in value to $220,000 (excluding interest payments)
• Gives you lowest valuation as there is typically lack of control premium built in
Steps in an LBO ✅1. Make assumptions about the purchase price and how much debt
and equity is used, and then you also have to make assumptions on things like the
interest rate on debt, revenue, margins
2. Second, you create a source and uses table basically showing how you're financing
the deal and how much capital you're using to buy the company's equity, pay off any
existing debt, and on top of that, pay the transaction fees associated with the LBO
3. Next, you need to adjust the company's BALANCE SHEET for the new debt and
equity values and anything else created in the deal, such as goodwill and intangibles
4. After that, you would project out their financials, and then you would create a debt
schedule showing how much debt is paid off each year.
5. Finally, I would make some assumptions on the exit multiple after 3-5 years and then
look at the range of values for the EBITDA exit multiple, and use those to calculate the
returns in each case
LBO Financing ✅• Bank Debt
, o Lower cost option is bank debt for PE firm, which may be used if planning a major
expansion or CapEx and don't want to be restricted by incurrence covenants
o Requires maintenance covenants
▪ Total Debt/EBITDA must be below 4x
▪ EBITDA/interest expense must always be above 2x
▪ Less risky because secured by collateral and also tends to come with 10-20% annual
principal repayments
• High-Yield Debt
o Might use high-yield if planning on refinancing or don't believe their returns are too
sensitive to interest payments, and have no plans for expansions/acquisitions
o No principal repayments
o Requires incurrence covenants
▪ Company cannot acquire another company or sell off its assets
How Do You Create Value in an LBO? ✅• Deleveraging
o Using available FCFs to repay debt
• Operation improvements
o Top line growth
▪ Market expansion
▪ Market share gains
o Margin improvements and improved efficiencies
• Multiple expansion
o Can be a result of operating improvements
o Typically, assume entry and exit at same multiple
Key Constituents in an LBO ✅• Target shareholders (seller)
• Lenders
• Private Equity Sponsor (buyer)
What Happens to Debt During LBO ✅• If PE company ASSUMES debt, then debt
remains on balance sheet and shows up in both sources and uses
• If PE firm REFINANCES debt, then it pays it off and replaces it with new debt that it
raises to acquire the company. Refinancing means additional funds are required, so
purchase price goes up. Existing debt shows up ONLY in the uses column
• Need to keep a minimum cash balance to pay employees and SG&A, so can't use
100% of cash flow to repay debt each year
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