Advanced Valuation Lecture 5 Flashcards
Which forms of private equity are there?
- Venture capital
- Growth capital
- LBO
- Distressed capital > the debt is often traded at a discount, and you buy it. The buyer exercises control to get an equity position
Remark: the DCF outcome is the pre-money valuation. If you add your investment, you get the post-money valuation.
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You have 2 types of IRR definitions
- Gross IRR = if you buy and sell a company, you make a return on it.
- Net IRR = returns the investors make, especially the LPs.
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The difference is the compensation for the PE
What kind of equity financing is used in an LBO?
- Ordinary shares
- Preferred shares
- Shareholder loan
Note on the purchase price of an LBO:
The purchase price is a proxy for the enterprise value since you also need to refinance the existing debt. Part of the transaction costs is fees for the banks that lend you the money to finance the deal.
What is a shareholder loan and why is it used in the financing deal?
It is a loan provided by the PE firm themselves to the target company. This is actually a form of equity, as it is deeply subordinated to senior debt and subordinated debt.
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It is tax-driven, as the interest is tax-deductible. But is now limited.
What is a vendor loan?
A vendor loan is a loan provided by the seller to the buyer if other lenders do not want to lend more. In order to meet the target IRR for the PE, a vendor loan is an option to bridge the gap.
What is the entry multiple?
Entry multiples exclude transaction costs and are based on last twelve months performance
(purchase price / Normalized LTM EBIT(D)A)
How are managers incentivised?
They typically get 10% of the ordinary shares. That way they can invest a relatively low amount of money. But all the value upside is captured by the ordinary shares, as the shareholder loan and the preferred equity have fixed yield. If it’s successful, management will make a lot of money.
What does leveraged finance do?
As a bank, you commit to a PE firm to deliver a debt package. And sometimes, you sell this debt to the market afterwards. Sometimes at a discount.
What are typical LBO debt instruments?
- Senior debt = Term A & B / facilities
- Second lien
- High yield bonds/notes > additional financing by tapping into public debt markets
- Mezzanine
- PIK / PIYC notes
- Vendor/shareholder loan
Characteristics of Term A and B/C financing. And what is a revolving credit facility?
A: often equal amortisation, so equal instalments. Often EURIBOR/LIBOR + spread
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B/C: often bullet loan. Typically 1Y longer tenure than Term A. Often EURIBOR/LIBOR + even bigger spread
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Banks often provide facilities, which is like a credit card. E.g., working capital facility. Draw the facility to fund WC investments, and use the proceeds generated by the WC to pay back the facility.
What is second lien?
Second lien debt = subordinated debt. Often bullet loan. Usually EURIBOR/LIBOR + 800bps spread. And with a tenure longer than the senior debt.
How is mezzanine financing constructed?
2 interest parts:
- Cash interest = interbank + margin
- PIK interest (rolled-up interest) = interest that accumulates on the liability
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Total interest is the combination of the 2.
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Often it also includes warrants, which they can exercise when the company is sold which gives them equity upside.
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In total, mezzanine financiers target IRR of 15%
How are PIK / PIYC notes constructed? Why would a PE accept this structure?
No cash interest, but only rolled-up interest on the liability.
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Typical interest is 18%. But it produces interest tax shields, so on an after tax basis, its yield is roughly 14%. But the PE themselves target, let’s say, 20%. So, it’s much more expensive to finance this with equity than with PIK/PIYC notes. And often there are no covenants involved here!