AsimpleModel LBO + PE

Question 1

What is a “cash-free
debt-free” basis?

Answer 1

This means that the acquirer assumes control of the business with a
cash balance of zero and oldco debt paid off (oldco debt is the sellers responsibility
and most debt has change of control provisions which require repayment of principal
in a control transaction).

Question 2

What is a cash sweep?

Answer 2

How much “extra %” of your cash flow that you amortise on your debt.

Question 3

HOw is financing fees handled in a LBO?

Answer 3

It is capitalised as a countra-liability which is written down over time.

Question 4

How is transaction fees handled in a LBO?

Answer 4

It is expenses, and adjusted in the balance sheet PRO FORMA accordingly.

Question 5

What is the advantages of Preferred Stock?

Answer 5

1) Advantage of making common stock “cheaper” - Preferred stock can be limited to par value and associated dividend. (This can be interesting when rewarding the management team)
2) Redeemable preferred stock provides the sponsor with the option of equiring the company to buy back the preferred stock. (giving partial return of capital) - this can boost the IRR (not MOIC)

Question 6

What is Preferred stock? (usually)

Answer 6

Preferred Stock – A class of ownership that has a claim on the assets and earnings of a business ahead of common stock. Preferred stock is issued with a face value and generally pays or accrues a dividend as a percent of face value.

Question 7

What is a convertible preferred stock? (usually)

Answer 7

Convertible Preferred Stock – If the shares of preferred stock issued are convertible, it means that at the option of the security holder, or the option of the board of directors, or at a predetermined date, the preferred stock shares can be converted into shares of common stock.

Question 8

What is a redeemable preferred stock? (usually)

Answer 8

• Redeemable Preferred Stock (also referred to as “callable”) – If the shares of preferred stock issued are redeemable, it means that the issuer (the company) can buy them back at a defined price, which is typically par value. In such an event, any accrued and unpaid dividends are generally paid out as well.

Question 9

How does the management company get compensated?

Answer 9

Portfolio company fees and Management fees.

Question 10

How does the general partnership get compensated?

Answer 10

Carried Interest.

Question 11

The financial sponsor is comprised of which of the following:

Answer 11

The management company and the General partnership!

Question 12

Which options best define the General Partner?

The entity with the legal authority to make decisions for the fund.
The operating entity that employs the investment professionals.
The entity that assumes all legal liability.
The entity that earns the bulk of the management fee.

Answer 12

The entity with the legal authority to make decisions for the fund.

The entity that assumes all legal liability.

Question 13

According to industry data, how many opportunities do PE firms evaluate for every 1 to 2 deals closed?

Answer 13

10+

Question 14

In the Indication of Interest, how is enterprise value expressed? (valuation range or specific value)

Answer 14

As a valuation range

Question 15

True/false: The Letter of Intent helps shape the Stock Purchase Agreement.

Answer 15

True

Question 16

Every investment is unique, but what is the common variable that is important in all transactions?

Answer 16

Risk! (and price is a derivative of risk)

Question 17

Per Michael Porter there are two ways to compete, by charging lower prices or by developing _______ products and offerings.

Answer 17

differentiated (also focus can be one aspect)

Question 18

What’s the process from reaching out to a company to exclusivity?

Answer 18

1. Teaser
2. Confidential agreement
3. Confidential information memorandum (CIM)
4. Indication of interest
5. Letter of Intent (non-binding agreement)

Question 19

What is the use of a Letter of Intent?

Answer 19

It’s a non binding agreement to establish a precise value and secure exclusivity for the acquisition.

Question 20

True/false: The Letter of Intent is a fully binding document.

Answer 20

False

Question 21

True/false: Purchase price is the most heavily negotiated variable after the LOI is executed.

Answer 21

False - because price should already be set (unless something material is found)

Question 22

Attempting to renegotiate the LOI without any material findings is frequently referred to as a _____.

Answer 22

Re-trade

Question 23

True/False: Most control equity transactions (where the Buyer acquires a control equity stake) are structured on a cash free, debt free basis.

Answer 23

True

Question 24

What is the logic behind a cash free balance sheet?

Answer 24

The assumption that the company will have a normalized level of working capital.

Question 25

True/False: The buyer is responsible for the amount of indebtedness at close.

Answer 25

False

Question 26

What is the five main advanced DD’s once LOI has been signed? (according to ASM)

Answer 26

1) CDD
2) Management DD
3) Financial
4) Legal
5) IT & Tech
(sometimes also HR, ESG etc.)

Question 27

What is the average costs of conducting advanced DD’s?

Answer 27

Between $250-750k (this can vary a lot)

Question 28

In software investing, what is the rule of 40?

Answer 28

Example of Rule of 40: Sum of revenue growth and profit margin for a healthy software business should exceed 40%. (A legacy player can have 5% growth but 35% margin), or a new player can have (50% growth, but losing margin)

Question 29

.

Answer 29

Failing to spot a product that is becoming a feature in a competitor’s platform
Assuming any disruption is too great and walking away or dis-investing prematurely
Overlooking potential gains in share of wallet
Believing a product can extend far beyond its core
Failing to tie R&D to customers’ priorities.

Question 30

What is the “Working Capital Adjustments?”

Answer 30

Its the adjustment designed in the Stock purchase agreement, impacting the final price paid
- This will adjust the WC to the normalised levels, before closing the transaction

Question 31

Why is the normalized WC important when closing the deal?

Answer 31

Because it will impact the final price transferred to the seller - if the WC is different from normalised levels of WC, this needs to be drawn from the escrow account.

Question 32

What is the Net working capital peg?

Answer 32

A net working capital peg or simply called the “Peg”, is a benchmark or baseline amount of net working capital that is agreed upon by the buyer and the seller and is usually determined toward the end of financial due diligence.

Question 33

Why is NWC so important to look at for high-growth companies?

Answer 33

Because if the company grows to quickly, the company can go bankrupt with “too positive” NWC - running out of cash.

Question 34

True/False: Smaller transactions are more likely to require syndicated financing.

Answer 34

False

Question 35

If a business files for bankruptcy and lacks the liquidity to make all creditors whole, _____ dictates who is first in line for repayment.

Answer 35

Seniority

Question 36

What are the three primary approaches to securing financing from lender groups:

Answer 36

Direct Placement: wherein the private equity firm goes straight to known lenders who tend to be long-term holders of the debt.
Private Placement: wherein the bank facilitates the placement of debt to a similar group of long-term holders.
Syndicated Financing: wherein a bank or group of banks will commit the necessary debt financing upfront themselves and then place it secondarily with a group of investors (who will either continue to hold it themselves or trade it). Syndicated loans facilitate transactions that require too large a loan for any single institution.

Question 37

What type of lender placements are smaller transactions more likely to have?

Answer 37

Direct placement, or private placement! (Larger transactions tend to have syndication)

Question 38

What is a tranche?

Answer 38

Trance refers to the full amount of a single security within the capital structure of a business transaction

Question 39

What are the 3 different type of debts available? (simplified)

Answer 39

1. Line of credit
2. Senior debt
3. Subordinated debt

Question 40

What are the characteristics of Line of credit?

Answer 40

Line of credit summary:
Can be drawn down, repaid and drawn again
Most likely used for working capital need, small add-on acquisition or servicing debt
Pay interest on drawn amount + commitment fee on roof of credit line

Question 41

What are the characteristics of senior debt?

Answer 41

Senior Debt Summary:
- Most senior in the capital structure (with the exception of the L.O.C.).
- More aggressive amortization schedule (rate at which principal is paid back).
- Floating interest rate.

Question 42

What are the characteristics of subordinated debt?

Answer 42

Subordinated Debt Summary:
- Junior to senior debt in the capital structure.
- No amortization schedule, or a substantially less burdensome amortization schedule.
- Fixed interest rate.
- Sometimes comes with warrants or an equity co-invest opportunity attached.

Question 43

How is the interest payments typically structured?

Answer 43

Interest payments:
- For bank debt and most subordinated debt structures, interest is generally due either monthly or quarterly.
- For bonds, the interest rate is more accurately called the coupon rate, and payment is typically made semiannually (every six months).

Question 44

What has driven the higher multiple expansion the last 5-10 years?

Answer 44

The industry multiple expansion has been supported by:
1. Persistently declining interest rate (now impacted)
2. Increasing competition for transactions (now halted)
3. Record levels of “dry powder” (still true)
4. Available financing for acquisitions (still roughly true)