Key Rule #1

Question 1

Why do sponsors make acquisitions?

Answer 1

same reasons cos do
- asking price < PV FCF
- IRR > WACC

Question 2

How do sponsors make acquisitions?

Answer 2

• look for undervalued cos that could yield high returns if managed properly
• pay for it
• PE firm runs co, makes improvements
• sell co

Question 3

How do sponsors look for undervalued cos?

Answer 3

• IRR vs DR
• Does it meet firm’s target?

Question 4

How do sponsors pay for their companies?

Answer 4

• cash (investor equity) + debt

Question 5

What is cash also known as for sponsors acquiring cos?

Answer 5

investor equity

Question 6

Why don’t sponsors use stock to pay for co?

Answer 6

• PE firmst not usually listed
• holding periods are too short

Question 7

Why do sponsors use debt when paying for co?

Answer 7

Leverage amplifies returns

Question 8

Why does leverage amplify returns?

Answer 8

• use as much debt as possible
• want to decrease upfront cost of acquiring co
• TVOM = $ worth more today than tomorrow
• IRR increase greater % if you decrease purchase price than increase exit price by same amt in 5 years
• Even if cash flow and net proceeds lower upfront compensates for this.

Question 9

What is the downside of using so much debt to buy co?

Answer 9

leverage makes bad deals worse

Question 10

What happens when sponsor sells co?

Answer 10

use proceeds to repay debt
earn high IRR and MoM mult

Question 11

Sketch out the deal team structure

Answer 11

Question 12

What is an LBO?

Answer 12

PE firm acquires a company using a combination of Debt and Equity
operates it for several years
sells the company at the end of the
period to realize a return on its investment

During the ownership period, the PE firm uses the company’s cash flows to pay for the interest expense on the Debt and to repay the Debt principal.

Question 13

How does leverage amplify returns?

Answer 13

if the deal performs well, the PE firm will realize higher returns than if it had bought the company with 100% Equity.

Question 14

What is a secondary benefit of using so much debt to acquire cos?

Answer 14

PE firm has more available capital to buy other cos

Question 15

Describe the legal structure of an LBO

Answer 15

• PE firm forms a “holding company,” which it owns,
• “holding company” acquires the real company.
• The banks and other lenders lend to this Holding Company so that the Debt remains at the “HoldCo” level.
• Managers and executives that retain ownership after the deal closes also have shares in this Holding Company.

Question 16

Why is the legal structure of a deal impt?

Answer 16

• means that PE firm not on hook for debt it uses on the deal
• up to acquired co to repay it
• acquired co borrows the money so that PE firm can do the deal

Question 17

What is the ideal LBO candidate?

Answer 17

• if the price is right (co undervalued)
• stable & predictable cash flows
• lots of tangible assets
• limited WC and capex reqs
• strong and defensible market position
• ability to reduce costs and increase margins
• undervalued biz or assets

Question 18

How can an LBO create value for the sponsors?

Answer 18

• using available FCF to repay debt
• operating improvements
• multiple expansion from operating improvements

Question 19

Explain LBO in simplest language?

Answer 19

• buying a house w mortgage and renting it out
• house is bought, leverage put on to reduce equity injection
• cash flows from rent (earnings) pay down debt and increase value of equity

Question 20

How do LBOs increase value of company?

Answer 20

• reduce WACC by adding debt that is cheaper on after-tax basis
• realizing operational efficiencies
• increasing ROE through financial leverage
• reduction of public listing costs by taking firm private
• private ownership allows for long-term strategic thinking

Question 21

How do steady and predictable cash flows make a good LBO target?

Answer 21

better ability to pay down debt

Question 22

How does large amt of tangible assets make a good LBO target?

Answer 22

more collateral for loans and help increase leverage

Question 23

How do limited WC and capex reqs make a good LBO target?

Answer 23

high WC and high capex mean less FCF which means less to pay down debt

Question 24

How do strong and defensible market pos make a good LBO target?

Answer 24

makes cash flow less risky

Question 25

How do ability to reduce costs and increase margins make a good LBO target?

Answer 25

increase cash available to pay down debt

Question 26

How do undervalued biz or assets make a good LBO target?

Answer 26

divestible assets can reduce debt burden of buyout