AsimpleModel LBO + PE Flashcards
What is a “cash-free
debt-free” basis?
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).
What is a cash sweep?
How much “extra %” of your cash flow that you amortise on your debt.
HOw is financing fees handled in a LBO?
It is capitalised as a countra-liability which is written down over time.
How is transaction fees handled in a LBO?
It is expenses, and adjusted in the balance sheet PRO FORMA accordingly.
What is the advantages of Preferred Stock?
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)
What is Preferred stock? (usually)
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.
What is a convertible preferred stock? (usually)
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.
What is a redeemable preferred stock? (usually)
- 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.
How does the management company get compensated?
Portfolio company fees and Management fees.
How does the general partnership get compensated?
Carried Interest.
The financial sponsor is comprised of which of the following:
The management company and the General partnership!
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.
The entity with the legal authority to make decisions for the fund.
The entity that assumes all legal liability.
According to industry data, how many opportunities do PE firms evaluate for every 1 to 2 deals closed?
10+
In the Indication of Interest, how is enterprise value expressed? (valuation range or specific value)
As a valuation range
True/false: The Letter of Intent helps shape the Stock Purchase Agreement.
True
Every investment is unique, but what is the common variable that is important in all transactions?
Risk! (and price is a derivative of risk)
Per Michael Porter there are two ways to compete, by charging lower prices or by developing _______ products and offerings.
differentiated (also focus can be one aspect)
What’s the process from reaching out to a company to exclusivity?
- Teaser
- Confidential agreement
- Confidential information memorandum (CIM)
- Indication of interest
- Letter of Intent (non-binding agreement)
What is the use of a Letter of Intent?
It’s a non binding agreement to establish a precise value and secure exclusivity for the acquisition.
True/false: The Letter of Intent is a fully binding document.
False
True/false: Purchase price is the most heavily negotiated variable after the LOI is executed.
False - because price should already be set (unless something material is found)
Attempting to renegotiate the LOI without any material findings is frequently referred to as a _____.
Re-trade
True/False: Most control equity transactions (where the Buyer acquires a control equity stake) are structured on a cash free, debt free basis.
True
What is the logic behind a cash free balance sheet?
The assumption that the company will have a normalized level of working capital.
True/False: The buyer is responsible for the amount of indebtedness at close.
False
What is the five main advanced DD’s once LOI has been signed? (according to ASM)
1) CDD
2) Management DD
3) Financial
4) Legal
5) IT & Tech
(sometimes also HR, ESG etc.)
What is the average costs of conducting advanced DD’s?
Between $250-750k (this can vary a lot)
In software investing, what is the rule of 40?
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)
.
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.
What is the “Working Capital Adjustments?”
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
Why is the normalized WC important when closing the deal?
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.
What is the Net working capital peg?
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.
Why is NWC so important to look at for high-growth companies?
Because if the company grows to quickly, the company can go bankrupt with “too positive” NWC - running out of cash.
True/False: Smaller transactions are more likely to require syndicated financing.
False
If a business files for bankruptcy and lacks the liquidity to make all creditors whole, _____ dictates who is first in line for repayment.
Seniority
What are the three primary approaches to securing financing from lender groups:
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.
What type of lender placements are smaller transactions more likely to have?
Direct placement, or private placement! (Larger transactions tend to have syndication)
What is a tranche?
Trance refers to the full amount of a single security within the capital structure of a business transaction
What are the 3 different type of debts available? (simplified)
- Line of credit
- Senior debt
- Subordinated debt
What are the characteristics of Line of credit?
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
What are the characteristics of senior debt?
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.
What are the characteristics of subordinated debt?
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.
How is the interest payments typically structured?
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).
What has driven the higher multiple expansion the last 5-10 years?
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)
