Lecture 4 Flashcards
LBO
3 leverages than LBO uses
1) Financial Leverage
2) Tax Leverage
3) Managerial Leverage
Managerial Leverage
“Carrot and stick”, Carrot: mgmt. package (lot of money)
Stick: high leverage (bankrupcy risk)
Acquisition debt located?
HoldCo, PE fund can operate “debt pushdown” into OpCo; debt that foes to OpCO is most senior (will be repaid first and is closest to operating assets)
Shareholders loan in LBO
Loan guranteed by shareholders; bears interest which
1) tax deductible, will be repaid before equity
2) incentivie for mgmt. (reudces their IRR if performance is not good) reduces return provided to mgmt. vs PE
HoldCo seperate from OpCo
Legal entitiy that will bear acquisition debt of the LBO, usually you benefit from tax integration and have additional expenses: mgmt. fees at HoldCo, interest on SHL
Condition for leverage to be positive for ROE? What is the downside?
CoD post tax < ROCE –> higher ROE means higher risk (i.e. higher volatility of CF as your fixed costs increase because of higher interest expenses and debt principal reimbursement)
2 (dis-)advantages of financial leverage
Advantages: 1) boosts return since value gains not shared eqully (IRR), 2) reduces taxes;
Disadvantage: 1) higher default risk, 2) higher volatility
Condition to benefit from tax consolidation (in France)
Subsidiary has to be owned by a min. of 95% by the parent
Why debt pushdown can be considered as an abuse?
Push down too much debt; OpCo bears the risk of acquisition debt (financial assistance rule) and you put in jeopardy all stakeholder of OpCo (especially problem if you have NCI at OpCo level)
Financial assistance rule can also apply if acquisition debt located at OpCo is sseking to get gurantees from the Operating assets of OpCo
5 key levers to create Shareholders value in LBOs?
- Deleveraging
- Enhance top line (vc)
- Operational Improvement (vc)
- tax advantages
- multiple expansion
inside these drivers the key driver is IMHO “mgmt. discipline”, incentives and coaching
Affect on purchase price
1 factor: availability of financing and therefore the level of ND/EBITDA reachable
- EV
- Assessment of Business Plan
- IRR
- cash generation capacity
Good LBO candidate
1) stable CF (mature)
2) good management
3) Top Line growth
4) Operational Improvements
5) Investment requirements
6) Exit
7) Purchase Price
8) suitable for buy and build strategy
LP vs. GP; how is return split?
Limited partners invest their money in a PE fund. Risk is limited to their investment and get return depending on selling price vs. purchase price
General Partners are managing the PE fund. Responsible for investing the money of the LPs. Paid through a mgmt. fee (flat) and a carried interest which is a return on the money they invest in the fund
“Classical” hurdle rate
IRR 15-25% (or. 2-2.5x Money Multiple)
Money Multiple
exit equity / entry equity (does not take into account the time value of money)
Used by PE when IRR is not good enough because of long holding period
