Advanced Qs

Question 1

Tenor
Seniority
Floating or Fixed Interest Rates
Amortisation
Call protection

Answer 1

Tenor: how many years will this loan be outstanding? What is its maturity period?
Seniority: refers to the order of claims on a company’s assets in a bankruptcy - senior secured holders first in line, senior unsecured, senior subordinated and then Equity Investor
Floating or Fixed interest rates - floating tied to LIBOR
Amortisation - straight line means company pays off principal in equal instalments each year
Call protection: is company prohibited from calling back - paying off or redeeming - security for a certain period.

Question 2

how are Call Protection and “Prepayment” different? Don’t they refer to the same concept?

Answer 2

Call protection refers to paying off the entire debt balanced, whereas prepayment refers to repaying part of the principal early, before the official maturity.

Question 3

What are some examples of incurrence covenants? Maintenance covenants?

Answer 3

IC:
- company cant take on more than 2 billion debt
- proceeds from any asset sales must be earmarked to repay debt
- company cant make acquisitions 200+ million in size
MC:
- total debt/ EBITDA can’t exceed 3x
- EBITDA/ Interest Expense can’t fall below 3x
- senior debt/ EBITDA cant exceed 2x

Question 4

Why you would you use PIK (Payment In Kind) debt rather than other types of debt, and how does it affect the debt schedules and the other statements?

Answer 4

Unlike normal debt, a PIK loan doesn’t require borrower to make cash interest payments - instead, the interest accrues to the loan principal, which goes up over time.
- PIK is riskier than other forms of debt and carries with it a higher interest rate than traditional Bank Debt, High-Yield Debt
- Adding it to the debt schedules is similar to adding High-Yield Debt with a bullet maturity – except instead of assuming cash interest payments, you assume that the interest accrues to the principal.
- You include this interest on the Income Statement, but you need to add back any PIK interest on the Cash Flow Statement because it’s a non-cash expense.

Question 5

How does Preferred Stock fit into these different financing methods? Isn’t it a type of Debt as well?

Answer 5

PS is similar to Debt and it would match the Mezzanine column in the table above most closely.
- preferred stock has lowest seniority in the capital structure and tends to have higher interest rates than other other types of Debt

Question 6

How do you treat Noncontrolling Interests (AKA Minority Interests) and Investments in Equity Interests (AKA Associate Companies) in an LBO model?

Answer 6

Normally you leave these alone and assume that nothing happens - so they show up both the sources and uses columns when you make assumptions in the beginning.
- You could assume that the private equity firm acquires one or both of these, in which case they would only show up in the Uses column – similar to refinancing Debt.

Question 7

What about “Excess Cash”? Why do you sometimes see that in a Sources & Uses table?

Answer 7

This represents the scenario where the company itself uses excess cash, to fund the transaction, this always shows up in the sources column
- it’s just like how you subtract when calculating enterprise value: an acquirer would receive that cash upon buying the company
- dont always see this item