PE & LBOs Flashcards
In a PE deal would you rather have 50 optimization in WC in year 4 and year 5 or 10 EBITDA improvement in year 5 (exit year)?
Rather have +10 in EBITDA usually; WC improvement increases FCF by 100 but EBITDA increase is multiplied by exit multiple (e.g. +10 * 10x EBITDA = +100) and increases FCF in year 5
What makes an ideal LBO Candidate?
- Mature Industry
- Not very cyclical company
- Clean balance sheet with low amount of outstanding debt
- Strong management team
- Low WC requirements and steady cash-flows
- Low future Capex
- Feasible exit options
- Growth opportunities
- Strong market position
- Possibility of selling non-core or underperforming assets
How would you build an LBO?
- EBITDA etc. from Business Plan
- Assumptions for Sources & Uses
- Modelling of financing tranches
- Modelling of IS up to NI
- Modelling LFCF
- Assumptions for Exit Multiple
- Calculation of Return
What is the biggest problem in an LBO in building a debt schedule for an RCF (revolving credit facility) and how can it be solved?
Problem in calculating RCF is in times of losses, RCF is used but then interest also has to be paid and also changes cash flow again which leads to circular connections. It would be best to model the LBO on a quarterly basis instead of annually to get minimal time lag.
How do you get to Entry and Exit Multiples?
Entry multiple from football field or by putting in goal IRR and calculating back to required Entry multiple. Exit multiple is usually assumed equal to Entry multiple because higher exit multiple is very aggressive assumption.
Do you need to calculate NOPAT in an LBO?
No, never. It is a theoretical metric that is used in DCF but not in LBO.
Can you use LBO to determine today’s company value?
Yes, you need EV at Exit and Net Debt (as well as potential other relevant positions) to get Equity Value. This can then be discounted over planning horizon with LBO typical IRR of 20-30% to get PV of Equity. Assumes that company can’t be valued more than LBO makes of it.
How are UFCF and LFCF calculated in an LBO?
EBITDA - Capex - WC - Cash tax payments \+ Any other non-cash items included in P&L - Any other cash items not included in P&L = FCF to Firm (UFCF) - Interest payments - Debt amortization = FCF to Equity (LFCF)
How would you finance an LBO?
As much debt as possible. Bank loan (“senior loan”) with additional second lien or mezzanine capital. Secondly, a HY Bond and third a combination of bonds and loan. Fourth you could combine senior loan, second lien and mezzanine capital into one unitranche loan.
What is a dividend recap in an LBO?
Take on additional debt to boost returns and invest further. Other reason would be to get money out of company without selling equity if there is still a high upside on the investment or you just don’t want to sell it (after a couple of years…).
What happens in the financial statements during a dividend recap?
- No changes in IS (possibly transaction costs)
- Liabilities and Cash increase shortly on BS and then decrease again after payout
- CFS reflects this BS effect. CF from financing shows inflow from debt and outflow from dividend
After that, especially IS is touched. Interest increases, taxes and NI decrease. RE therefore grows at a slower rate. CF from Operations decreases as higher interest has to be paid.
What are pros and cons of an LBO?
Pros:
- LBOs are detailed
- Central part of PE Deal
- Good cross-check for DCF and multiples
- Inputs usually available
- Recognizes change in capital structure
- No need for peer group
Cons:
- Needs lots of input parameters
- Volatile if cyclical business model
- Change in capital structure (debt repayment etc.) can be very time intensive
- Sensitive outputs
- Results not always intuitive
- Because of entanglement very time intensive
How much debt is usually used in an LBO?
ND/EBITDDA usually between 5-7x depending on cyclicality and business model.
How do you pick purchase and exit multiples?
Using comparables. Sometimes you set purchase and exit multiples based on specific IRR target but this is just for valuation purposes if you’re using an LBO to value a company.
PE firm acquires $100m EBITDA company for 10x using 60% debt. EBITDA grows to $150m by Y5 but exit multiple drops to 9x. Company repays $250m debt and generates no extra cash. What’s the IRR?
Entry: $400m equity to buy company
Exit: $1’350 EV (9 * $150). Remaining debt of $350 (600 – 250) will be repaid: $1’000 equity value
Multiple: 2.5x ($1’000 / $400) or 20% IRR (15% IRR = 2x; 25% IRR = 3x)
What are the main value drivers in an LBO?
Sorted by largest to smallest driver (usually)
- Multiple Expansion: Exit multiple > entry multiple
- Leverage
- Financials: Revenue, EBITDA, margin improvements
You buy a $100 EBITDA business for 10x EBITDA and sell sell it for 10x EBITDA in 5 years. You use 5x Debt/EBITDA and repay 50% over the 5 years. How much does EBITDA need to grow to realize a 20% IRR?
Purch. Price of $1000 ($500 debt; $500 equity); 20% over 5 years corresponds to ~2.5x, so equity needs to grow to $1’250 ($500 * 2.5). Add $250 of remaining debt (after repaying $250) to get to exit EV of $1’500. Assuming 10x multiple EBITDA needs to grow to $150.
Could a PE firm earn a 20% IRR if it buys a company for an EV of $1bn and sells it for an EV of $1bn after 5 years?
Yes, cash flows over those 5 years make this possible.
How is the FCF in an LBO different from FCF in a DCF?
- LBO determines company’s ability to repay debt, not implied value of entire company
- FCF in LBO starts with Net Income, not NOPAT as in DCF
- FCF is end point in DCF, in LBO you have to go beyond it like minimum cash requirement, potential other obligations etc. to find out what’s possible to repay
If a company has $10m in sales and $5m in EBITDA what is the most appealing option: 20% more units sold, 20% higher prices or 20% fewer expenses?
20% higher prices because it flows through to EBITDA; 20% more units incurs high variable costs; cutting expenses by 20% only increases EBITDA by $1m
How do you use LBO to value a company and why is it considered a floor valuation?
You set a target return (e.g. IRR of 25%) and back-solve it to get your financials. Floor valuation because PE almost always pays less than strategist
How is the BS adjusted in an LBO?
- Liabilities & Equities side adjusted: New debt is added, and Shareholders’ Equity is wiped out and replaced by contribution of PE
- Asset side: Cash adj. for any cash used to finance transaction and Goodwill & Other Intangibles is used as a plug to balance both sides
Strategist usually prefers cash payment, why does PE firm use debt in LBO?
- PE doesn’t want to hold company long-term; it’s using leverage to boost return rather than to think about cash as an expense
- In LBO, debt is owned by the company, so the portfolio company bears risk; the strategist bears the full risk
Do you need to project all 3 statements in an LBO model? Are there any shortcuts?
Yes, there are shortcuts, you don’t need full BS but some type of IS and CFS.
Which transaction costs does a PE Investor need to consider when planning a transaction?
- Fee for IB that plans transaction
- Legal fees
- Fees for newly issued debt
What is a Secondary LBO?
PE sells to other PE and also considers LBO investment.
PE buys company for EV of €100m and pays €5m transaction costs. In 5 years, he sells it for €100m and also pays €5m transaction costs. Has he certainly lost money?
No, you don’t know how much cash it generated during the holding period. Also: dividend recap.
What’s the J-Curve in an LBO?
IRR effect over lifetime. In first few years, return is usually negative because of high transaction, legal etc. fees and Capex investments. These effects start to become profitable usually after first few years so that return is positive from year 3 on in most cases.
What are PE Dachfonds?
Don’t invest in companies and don’t do LBOs. They are more like traditional investors that collect money and invest in funds including PE funds. Benefit of diversifying across PE funds but has to pay management fee twice.
How much equity is usually used in an LBO?
30-50% measured on EV.
How do you find out how much debt you can realistically use in an LBO?
- Compare yours to other LBOs that happened recently and how much debt they used
- Ability to carry debt. Interest vs. EBITDA as well as amortization with operating CF.
Why does it make sense for a PE to buy a public company and take it private?
- Undervalued
- No private company that fulfills investment case
- Cost savings for previously public company (less compliance, accounting etc.)
What are the cons of a highly leveraged capital structure?
Very high risk of not being able to pay interest if cash flows are cyclical. Additionally, high interest payments leave less for capex and expansion becomes more difficult which could lead to falling margins.
For a public company, high leverage could undervalue equity as investors avoid the additional risk which could attract hostile takeovers.
What’s the difference between bank debt and HY debt?
- HY tends to have higher interest
- HY rates are usually fixed, while bank uses floating
- HY has incurrence covenants while banks use maintenance covenants. Incurrence prevents you from doing sth. (e.g. selling the asset), while maintenance require you to maintain sth. (Debt/EBITDA ratio)
- Bank debt is usually amortized, whereas HY is paid as bullet at maturity
Why would you use bank debt rather than HY?
- Concerned about interest payments or wants lower-cost option
- Major Capex investment necessary
- Doesn’t want to be restricted by incurrence covenants
Why would PE prefer HY debt?
- Wants to refinance at some point
- Not too sensitive returns to interest payments
- No major expansion or Capex
- Less covenants
- When interest rates are low and investors look for higher yielding bonds
Which financial covenants are usually agreed upon in an LBO?
DSCR (Debt Service Coverage Ratio) Covenant = Operating CF / (Interest + Amortization)
ICR (Interest Coverage Ratio) = Adj. EBITDA / Interest
Leverage Cov. = ND / Adj. EBITDA
Capex Covenant
How would an asset write-up or -down affect an LBO model? How do you adjust the BS?
Very similar to merger model; key differences:
- In LBO you assume existing Shareholders’ Equity is wiped out and replaced by equity the PE firm contributes. You also add Pref. Stock, Management Rollover etc.
- In LBO you usually add a lot more tranches than in a merger model
- In LBO you’re combining two companies’ BS
Normally we care about IRR for equity investors in LBO but how do we calculate it for debt investors?
You simply use interest and principal payments as returns.
Why might a PE allot some of a company’s new equity in an LBO to a management pool?
For same reason you have Earnouts in M&A: incentivize management. Difference is, there is no technical limit on how much management might receive from this option pool.
In the LBO model, you would need to calculate per-share purchase price when PE exits the investment and calculate how much of the proceeds go to management team based on Treasury Stock Method. An option pool would reduce PE firm’s return but this should be offset by incentivized management
Why would you use PIK (Payment In Kind) debt rather than other types of debt and how does it affect debt schedules?
PIK does not require cash interest payments. Rather it accrues to the loan principal, therefore it is riskier. To the debt schedule it is similar to HY debt with a bullet maturity. Interest payments are included on the IS but not on CFS because it’s a non-cash expense.
What are examples of incurrence and maintenance covenants?
Incurrence:
- Cannont take on more than $2b debt
- Proceeds from asset sales must be used to repay debt
- Cannot spend more than $100m on Capex each year
Maintenance:
- Debt/EBITDA cannot exceed 3.0x
- EBITDA/Interest Expense cannot fall below 3.0x
Just like normal M&A deal you can use stock or asset purchase in LBO. Can you also use Section 338(h)(10)?
In most cases no because Section 338(h)(10) requires buyer to be a C corporation. Most PE funds are LLCs or Limited Partnership and for their LBOs they create LLC shell companies.
How do you calculate optional repayments on debt in an LBO model?
You are looking at optional repayments in Revolver or Term Loan (HY doesn’t have prepayment option). First you check how much cash flow you have available based on beginning cash, min. cash CF available for debt repayment from CFS and how much you use to make mandatory debt repayments. Then if you’ve used your Revolver, you pay off the maximum amount that you can with the CF available.
With the still remaining cash, you can pay off Term Loan A, taking into account that you might have paid off some principal as part of Mandatory Repayments. Then you do the same thing with Term Loan B.
Explain how a Revolver is used in an LBO model
You use a Revolver when the cash required for Mandatory Debt Repayments exceeds the cash flow you have available to repay them (Revolver = Max(0, Tot. Mandatory Debt Repayment – Cash Available to Repay Debt))
How would you optimize the IS in an LBO model?
- Cost savings: laying off employees, etc.
- New Depr. Expense: From any PP&E write-ups
- New Amortization Exp.: written up intangibles and form capitalized financing fees
- Interest Expense on LBO Debt: Cash and PIK interest
- Sponsor Management Fees
- Common Stock Dividend
- Preferred Stock Dividend
In an LBO is it possible for debt investors to get a higher return than the PE firm?
Yes, HY investors get around 10-15% and PE doesn’t necessarily generate high returns after repaying debt etc.
Most of the time increased leverage means increased IRR; how could increased leverage reduce IRR?
Very rare but increased leverage could increased interest payments so much that return would decrease. You’d need a combination of:
- Lack of CF or EBITDA growth
- High interest payments
- High purchase multiple to make high IRR even more difficult
When you have two companies that are similar but with different valuation multiples, describe what could be the cause of that. (Blackstone)
Recent shocks (won lawsuit against the other), different management teams, first-mover advantage, patent.
Which bond is more valuable, the one with only one payment at maturity or the one with periodic payment along the time till maturity? (Blackstone)
If the sum of the (non-discounted) cash-flows is the same, then the bond with periodic payments is more valuable, as the cash-flows that are discounted have a higher weight if they are paid earlier.
If you had questions that no one had answers to, how would you handle it? (KKR)
Try to break the question down into smaller problems and then try to solve them (with or without the help of others).
If your investment increased 20% and you now have $60 how much did you start with? (Blackstone)
If x * (1 + 20%) = 60 then x = 50
If our firm wanted to sell one of our business units, how would you go about valuing that segment? (Blackstone)
Look at how much money we make and how we use synergies of incredibly smart people, strong network and good collaboration to invest in great businesses and collect fees from LPs. Project these generated cash flows by looking at fund investment cycles and see when fees are paid.
Would you rather win the lottery today and get $1m lump sum now or earn $2,000 every month for the rest of your life? (KKR)
$2k for 60 years would be PV of (1/0.02 – 1/(0.02 * 1.02^60)) * 2k * 12 = ~840k
Take the $1m because it is more and I can invest the money right away.
How do we make money? (Blackstone)
By collecting fees from investors that trust us and give us their money to make great investments.
When flipping a coin infinitely, is the pattern HHT or HTH more likely to appear? What is the probability that one appears before the other? (Blackstone)
HHT is more likely (2/3 vs. 1/3 for HTH) and more likely to appear earlier. If the sequence starts with T, you can ignore all of the T’s, until you have H’s. Then there are four possibilities (HHH, HHT, HTH, HTT).
So you have the first H and afterwards if there is another H, you know that HHT will win, because either you choose the second sequence or the first which will eventually have a T too (e.g. HHHHT). HTH only wins for the third example, so we can ignore number four (HTT).
Out of the three possibilities (HHH, HHT, HTH), HHT therefore wins the first two and HTH only the third.
What does our business do? (Goldman Sachs Principal Investments)
Invest in great business with the aim of improving them and selling them for more than what we invested.
You operate a trucking company that ships supplies between Las Vegas and Los Angles. How would you think about growing revenues? (Bain Capital)
Would have to look closer into the business model but some ideas: Increase fleet size, number of times driving back and forth, hiring more drivers, increasing truck capacity, buy competitors, drive more routes, increase efficiency (never drive empty trucks)…
How would you decide on the expansion strategy for a food catering company subsidiary in France, considering the competitive environment (Bain Capital)
M&A (buy competitors), focus on specific segment (organic, high-protein, very high quality), lower prices, make deals with suppliers of current countries etc.
What is ENI (Economic Net Income)?
US GAAP requires consolidation of funds and investment vehicles which make operating performance of GP hard to determine. ENI should help with that. It is a pre-tax financial measurement. ENI = Fund-level fee revenue \+ Total Performance Fees \+ Total Investment Income \+ Interest & Other Income - Direct Base Compensation - Performance fee-related compensation (realized and unrealized) - G&A and Other Indirect Expenses - Interest Expense
What are Distributable Earnings?
Similar to ENI but only includes cash-generating portion of the performance and investment related revenues and compensation expenses. It still includes some non-cash expenses (equity compensation from annual employee grants and depreciation). It is a pre-tax metric. Distributable Earnings = Fund-level fee revenue \+ Realized Performance Fees \+ Realized Investment Income \+ Interest & Other Income - Direct Base Compensation - Realized Performance fee-related compensation - G&A and Other Indirect Expenses - Interest Expense
Let’s do a Paper LBO with the following assumptions: Holding period of 5 years, 22x Entry (10x Debt @3% bullet, 12x Equity), 20x Exit. Revenue is $100m and grows by 10% each year. Flat margins at 40%. 50% tax rate. Capex and D&A are 5% of revenue. WC outflow of 1 each year. What is your MOIC and IRR? (Blackstone)
Exactly 2x/15% IRR (Equity @ Exit is 960; Cum. FCF are 80)
Let’s do another Paper LBO. $500m revenue growing at 5% p.a. over 5 years. 20% flat EBITDA margins. Exit 10x, $30m fees today. $500m debt that you can use. You generate $300 in FCF over the 5 years. How much money do you need to put in to get a 15% IRR? (Blackstone)
EBITDA in year 0 is 100, grows to 128 in year 5. Therefore, we have EV of $1280 and Equity of $1’080m (-500 debt +300 cum. FCF). We have to put in $540m of equity in the beginning to get 2x or 15% IRR. Don’t get confused with the $30m of fees. We pay $540m in equity and $500m in debt and have to do everything with it (Sources of $500m debt and $540 equity = $1’040; therefore Purchase Price needs to be $1’010m because we subtract $30m of fees).
Follow-up question: If our exit multiple increases by 1x, how much higher will our IRR and MOIC be? (Blackstone)
Remember EBITDA in y5 is $128m, so EV increases by 128, bridge stays the same so equity will @Exit will be higher by 128m. Compaing the 128m to the 540m that we put in, we roughly get 0.25x in additional multiple (2x to 2.25x). We know 2x is 15% IRR and 2.5x is 20% IRR, so we have roughly 17.5%. Therefore, IRR increases by 2.5%.
Now we have that additional turn on our exit EBITDA but only want to have 15% IRR. How much more or less equity do we need to put in now? (Blackstone)
Again our bridge stays the same but exit equity is higher because EV is higher. Exit equity is now roughly 1200 (1080 + 128), so applying the 2x multiple (15% IRR) gives us 600 in Equity. Compared to the initial 540, we need to invest 60 more.
Assume everything stays the same (esp. in IS). What would happen if we have $50m of lease liabilities in the beginning. Would that mean we can pay more or less equity? (Blackstone)
Since we have $50m in the beginning that would mean they are included in our bridge as well. Usually, these liabilities are projected assuming the same growth as revenue (in our case 5%). After 5 years, we would therefore assume them to be $64m. This means, using our 2x multiple again, that we can put in $18m more in equity at the beginning (50 – 64 /2x) for the same amount of return. This holds true as long as our IRR is larger than the rate at which the liability grows (in our case the 5% revenue growth).
You have a company with the following assumptions: $100m revenue (year 0) with 2% revenue growth, 20% EBITDA margin (growing by 1% p.a.). Capex and D&A stay $5m over 5 years. NWC doesn’t change and you don’t have any taxes. You have 10x entry and exit multiples and finance it with 50% debt @5% (bullet repayment). (Blackstone)
Revenue grows to 110 in year 5, EBITDA to 28 (calculate 20%, 21%…,25% of $100 first and then add respective increase in revenues). Subtract D&A and Interest ($5m each) to get to NI of 11, 13, 14, 16, 18. FCF equals NI because D&A = Capex and ∆NWC = 0. Of the $200m EV @ entry, you pay $100m using cash. At the end you have $28m in EBITDA x 10 = EV of 280. You subtract 100 in debt and add the 72 of cum. FCF which results in 252 (2.5x/20% IRR).
What would be the unlevered return on the previous question? (Blackstone)
Since we don’t have any taxes, we don’t have any tax shield, which makes the question a lot easier to solve. We put in $200m equity in the beginning. At the end, we still have 280 in EV, subtract no debt but add a higher FCF than before. Before, we added 72, no we add an additional 25 (from 5 years of $5m interest payments). This results in an exit value of $377m. Dividing it by $200m gives us a 1.88x multiple, which is roughly 13% IRR.
You have two oil drilling companies A and B. Both have the same P/E ratio and market cap. Company A drills in the Gulf of Mexico, while company B drills in Norway. Now we have an external shock that increases the oil price. Which company should we invest in? (Blackstone)
Since both have the same P/E ratio and market cap, it means that they have to have the same earnings. However, drilling in Norway is more expensive than in the Gulf of Mexico. Therefore, company B must have higher earnings. An increase in oil price would therefore lead to a larger increase in revenues for company B in absolute terms and a stronger increase in Net income. Therefore, we should invest in company B (even though it has lower margins).
You have a company with 500 EV, 100 Net Debt on BS, 50 EBITDA, 50 Pension Liabilities and 50 Lease Liabilities. You buy it and can use up to 4x EBITDA of Debt with 5% fees on the debt and 10 in M&A fees. Who do you pay what? (Blackstone)
You want to look at the company on a cash-free/debt-free basis, so you subtract the 100 of net debt and are left with 400. You know that you can use 200 of debt (50 x 4) and have to pay 10 in fees for the debt. You subtract leases and pensions to get to 300 of equity. Your uses therefore consist of 300 purchase price, 50 lease liabilities, 50 pension liabilities, 10 in M&A fees and 10 in bank debt fees. Your sources have to equal 420 too so you use the 200 of debt that you have and 220 of equity.
Walk me through a basic LBO model.
Step 1 is making assumptions about:
- Purchase Price
- Debt/Equity ratio
- Interest Rate on Debt
- You might also assume something about the company’s operations, such as Revenue Growth or Margins, depending on how much information you have.
Step 2 is to create a Sources & Uses section:
- Shows how you finance the transaction and what you use the capital for
- This also tells you how much Investor Equity is required
Step 3 is to adjust the company’s Balance Sheet for:
- New Debt and Equity figures
- Add in Goodwill & Other Intangibles on the Assets side to make everything balance.
Step 4 to project out the company’s:
- Income Statement, Balance Sheet and Cash Flow Statement
- Determine how much debt is paid off each year
A. Do this based on the available Cash Flow and the required Interest Payments.
Step 5 you make assumptions about the exit after several years:
- Usually assuming an EBITDA Exit Multiple
- Calculate the return based on how much equity is returned to the firm.
Why would you use leverage when buying a company?
- To increase your returns
A. Remember, any debt you use in an LBO is not “your money”
i. Example:
If you’re paying $5 billion for a company, it’s easier to earn a high return on $2 billion of your own money and $3 billion borrowed from elsewhere vs. $3 billion of your own money and $2 billion of borrowed money.
- The firm has more capital available
A. Capital is used to purchase other companies because they’ve used leverage
What variables impact an LBO model the most?
- Purchase and Exit Multiples have the biggest impact on the returns of a model
- The amount of leverage (debt) used also has a significant impact
- Lastly, operational characteristics such as revenue growth and EBITDA margins
How do you pick purchase multiples and exit multiples in an LBO model?
The same way you do it anywhere else:
- Look at what comparable companies are trading at
- Look at the multiples similar LBO transactions have had
- Show a range of purchase and exit multiples using sensitivity tables
* Sometimes you set purchase and exit multiples based on a specific IRR target that you’re trying to achieve – but this is just for valuation purposes if you’re using an LBO model to value the company.*
What is an “ideal” candidate for an LBO?
“Ideal” candidates have:
- Stable and predictable cash flows
- Low-risk businesses
A. Not much need for ongoing investments such as Capital Expenditures
- An opportunity for expense reductions to boost their margins
* *A strong management team also helps, as does a base of assets to use as collateral for debt.*
* *The most important part is stable cash flow.*
How do you use an LBO model to value a company?
Why do we sometimes say that it sets the “floor valuation” for the company?
You use it to value a company by:
- Setting a targeted IRR (for example, 25%)
- Then back-solving in Excel to determine what purchase price the PE firm could pay to achieve that IRR
• This is sometimes called a “floor valuation” because PE firms almost always pay less for a company than strategic acquirers would.
Give an example of a “real-life” LBO.
The most common example is taking out a mortgage when you buy a house. Here’s how the analogy works:
1. Down Payment: Investor Equity in an LBO
2. Mortgage: Debt in an LBO
3. Mortgage Interest Payments: Debt Interest in an LBO
4. Mortgage Repayments: Debt Principal Repayments in an LBO
5. Selling the House: Selling the Company / Taking It Public in an LBO
Can you explain how the Balance Sheet is adjusted in an LBO model?
- First, the Liabilities & Equities side is adjusted –
A, The new debt is added on
B. The Shareholders’ Equity is “wiped out” and replaced by however much equity the private equity firm is contributing.
- On the Assets side we then have adjustments
A. The Cash is adjusted for any cash used to finance the transaction
B. The Goodwill & Other Intangibles are used as a “plug” to make the Balance Sheet balance.
- Depending on the transaction, there could be other effects as well – such as capitalized financing fees added to the Assets side.
Tell me about all the different kinds of debt you could use in an LBO and the differences between everything.
- REVOLVER: Lowest Int. Rate‚ Floating Cash Int.‚ 3-5 year tenor‚ not amortized‚ prepayment allowed‚ typ. investor: conservative banks‚ Senior Secured‚ Secured‚ No Call Protection‚ Maintenance Covenant
- TERM LOAN A: Low Int. Rate‚ Floating Cash Int.‚ 4-6 year tenor‚ straight-line amortized‚ prepayment allowed‚ typ. investor: conservative banks‚ Senior Secured‚ Secured‚ Sometimes Call Protection‚ Maintenance Covenant
- TERM LOAN B: Higher Int. Rate‚ Floating Cash Int.‚ 4-8 year tenor‚ minimal amortization‚ prepayment allowed‚ typ. investor: conservative banks‚ Senior Secured‚ Secured‚ Sometimes Call Protection‚ Maintenance Covenant
- SENIOR NOTES: Higher Int. Rate‚ Fixed Cash Int.‚ 7-10 year tenor‚ bullet pmt‚ prepayment not allowed‚ typ. investor: HFs/Merchant Banks/Mezzanine Funds‚ Senior Unsecured‚ Sometimes Secured‚ Yes Call Protection‚ Incurrence Covenant
- SUBORDINATED NOTES: Higher Int. Rate‚ Fixed Cash Int.‚ 8-10 year tenor‚ bullet pmt‚ prepayment not allowed‚ typ. investor: HFs/Merchant Banks/Mezzanine Funds‚ Senior Subordinated‚ Not Secured‚ Yes Call Protection‚ Incurrence Covenant
- MEZZANINE: Highest Int. Rate‚ Fixed Cash (or PIK) Int.‚ 8-12 year tenor‚ bullet pmt‚ prepayment not allowed‚ typ. investor: HFs/Merchant Banks/Mezzanine Funds‚ Equity‚ Not Secured‚ Yes Call Protection‚ Incurrence Covenant
NOTES:
- Each type of debt is arranged in order of rising interest rates - so Revolver has the lower interest rates‚ Term Loan A is slightly higher‚ B is slightly higher‚ Senior Notes are higher than Term Loan B and so on.
- “Seniority” refers to the order of claims on a company’s assets in a bankruptcy - the Senior Secured holders are first in line‚ followed by Senior Unsecured‚ Senior Subordinated‚ and then Equity Investors.
- “Floating” or “Fixed” Interest Rates: A “floating” interest rate is tied to LIBOR. For example‚ L + 100 means that the int. rate of the loan is whatever LIBOR is at currently‚ plus 100 basis point (1.00%). A fixed int. rate‚ on the other hand‚ would be 11%. It doesn’t “float” w/ LIBOR or any other rate.
- Amortization: “Straight Line” means the company pays off the principal in equal installments each year‚ while “bullet” means that the entire principal is due at the end of the loan’s lifecycle. “Minimal” just means a low percentage of the principal each year‚ usually in the 1-5% range.
- Call Protection: Is the company prohibited from “calling back” - paying off or redeeming - the security for a given period? This is beneficial for investors b/c they are guaranteed a certain number of interest payments.
