Purchase Price, Debt, and Sources & Uses Schedule Flashcards
What’s the true purchase price in a leveraged buyout?
Start with the Equity Purchase Price
the true price may be different based on a sources and uses schedule
Using excess cash to fund the deal reduced the true price, as do Equity Rollovers.
The true price is often close to the Purchase Enterprise Value, but it won’t be the same because of these issues.
How can you determine how much Debt a PE firm might use in an LBO and how many tranches there would be?
You look at recent, similar LBOs and use the median Debt/EBITDA levels from them as references; you could also look at highly leveraged public companies in the industry and check their Debt / EBITDA levels.
Then, you would test these assumptions by projecting the company’s leverage (Debt/EBITDA) and coverage (EBITDA / Interest) ratios over time.
Can you describe the different types of Debt a PE firm might use in a leveraged buyout, and why they might use them?
Debt is split into Secured Debt and Unsecured Debt.
Secured Debt - backed by collateral, tends to have lower, floating interest rates, early repayment of principal is allowed.
Unsecured Debt - not backed by collateral, interest rates tend to be higher, and early repayment is not allowed.
Why do the less risky, lower yielding forms of Debt amortize?
Amortization reduced credit risk but also reduces the potential returns. Since risk and potential returns are correlated, amortization should be a feature of less risky debt.
Why might a PE firm choose to use Term Loans rather than subordinate Notes in an LBO, if it has the choice between two capital structures with similar levels of leverage?
Term loans are less expensive than subordinate notes since interest rates are lower, and they give the company more flexibility with its cash flows since optional repayments are allowed in most cases.
Why might a PE firm do the opposite and use Subordinated Notes instead?
On the surface, this doesn’t make much sense because Subordinated notes are more expensive than term loans.
However, a PE firm might prefer subordinate notes if they doubt a company’s ability to comply with the maintenance covenants found in term loans.
Why might excess cash act as a funding source in an LBO, and why might its usage also cause controversy?
Excess cash might act as a funding source in an LBO if a company uses its Cash to repurchase its shares, reducing the number of shares that a PE firm has to purchase.
It’s not that the PE firm “gets” the company’s Excess Cash before the deal takes place - it’s that the company uses its cash to reduce the purchase price for the PE firm.
Pre-deal shareholders often object to such moves, saying that the company should have issued a Special Dividend to them or used the cash in a more productive way.
What’s the point of assuming a Minimum Cash Balance in an LBO?
The point is that all companies need some minimum amount of cash to continue running their business and delivering products to customers.
You can’t just assume that all the company’s Cash can be used to fund the deal or repay Debt after the deal takes place.
You must keep this minimum cash balance in mind if you assume that excess cash is used to fund an LBO, and you must factor it in when calculating how much Debt principal a company could potentially repay each year.
How might you estimate this Minimum Cash Balance if the company doesn’t disclose it?
You might look at how low its Cash Balance has fallen historically, or you might look at Cash as a % of Total Expenses and see how that figure has trended in the past.
How does an Equity Rollover affect the Sources & Uses schedule in an LBO?
The Equity Rollover counts as a Source of Funds because it reduced the amount of Debt and the Investor Equity that are required to do the deal.
The Equity Rollover also results in reduced ownership for the PE firm after the deal takes place.
