LBO Fundamentals

Question 1

What is an LBO?

Answer 1

• PE firms and Financial Sponsors pursue LBO transactions
• they use debt to amplify the returns they can generate for their investors
• the reason for using debt is to increase the potential for higher returns for the firms investors
• core drivers are: Purchase Price, Cash Flow, and EBITDA expansion

Question 2

What is the first step of an LBO?

Answer 2

Calculate Purchase Price (Enterprise Value)
- determine the price to pay by multiplying the EV/EBITDA multiple by the target company’s EBITDA. Then add back financing or advisory fees

Question 3

What is the second step of an LBO?

Answer 3

Determine Debt and Equity Funding
- determine the debt available based on the multiple of EBITDA
- determine Sponsor Equity: subtract Debt from Total Uses Sources of Funds

Question 4

What is step 3 of an LBO?

Answer 4

Project Cash Flows
- calculate Free Cash Flow over a 5th horizon, including Interet Expense
Start with:
EBITDA
- interest expense and income taxes
+/- Net working capital
- CAPEX
= Free Cash Flow

Question 5

What is step 4 of a LBO?

Answer 5

Calculate Exit Sale Value
- determine the sale price by multiplying an EV/EBITDA multiple by the target company’s EBITDA at exit.
- typically assumed to be the same as the purchase multiple

Question 6

What is Step 5 of an LBO?

Answer 6

Work on Exit Owner Value
- subtract the cumulative cash flows from the debt used to fund the deal. This will give you the debt that needs to be repaid when the Company is sold
- Exit Equity Value = Exit Sale Value - Debt repaid + excess cash on the balance sheet

Question 7

What is step 6 of an LBO?

Answer 7

Assess Investor Returns (IRR or MOIC)
- use the exit equity value and the initial sponsor equity to calculate the two metrics: IRR and MOIC
- IRR reflects the time weighted return to investors, MOIC reflects dollars returned v dollars invested
- the IRR is time weighted so things like an early exit and distort it