Session 7-8 Flashcards
What is the PE’s in an LBO?
Financial sponsor: provides equity and orchestrates deal
Creates an SPV to raise debt to carry out LBO
How does the investment bank assist the PE firm during an LBO?
Introduces potential targets, helps negotiate price & arrange exit
Arranges debt for acquisition & recapitalization
What does an ideal LBO target firm have?
Robust & stable cash flows (more debt, more returns)
Leverageable balance sheet (low existing debt so you can add more)
Low CAPEX so the firm has money left to finance debt and pay dividends
Quality, collateralizable assets
Assets available for sell
Capacity to cut costs
Competent Management
What is dividend recapitalization?
The target firm pays a large dividend to the holding company (i.e.PE firm) so they can retain 100% of their ownership position
What are the 2 types of dividend recapitalization?
Non-leveraged: uses excess cash flow or sells assets to pay
Leveraged: uses new debt if market and firm conditions allow for it
Benefits and Drawbacks of dividend recapitalization
Benefits
*PE firm partially monetizes the investment without having to exit
*Reduces exit pressure, provides a backup solution if other exit strategies fail
*PE’s downside investment risk is reduced, IRR is increased
*Can be quickly completed with limited involvement by management
Drawbacks
*Only a partial exit, and without an independent mark-to-market valuation
*Increases the target firm’s debt, may lead to tighter covenants
*If the target goes bankrupt, the PE firm’s reputation may suffer
What are the different steps of the LBO analysis?
1.Determine cash flow available for debt service
2.Determine debt available
3.Determine acquisition and projected exit price
4.Determine CCM and IRR
5.Determine funding sources
6.Determine investment structure
How do you calculate Enterprise Value?
Equity + debt - cash
What is EBITDA a proxy of?
Operating cash flows
Why is the EV/EBITDA multiple the standard
Because LBO targets are mature firms and EBITDA is preferred over NI
What should the PE do if IRR is under the hurdle rate?
Adjust deal terms: + debt - equity, lower acquisition price, reduce hurdle rate or abandon deal
What can a PE do if the CCM is not high enough?
Prolong exit till it can be done in better condition (get a higher exit value)
Who gives out senior debt?
Bank or syndicate
What are the different types of senior debt?
RCF, first lien term loan, second lien term loan
What are the differences between senior debt and junior debt
seniority, senior @ floating rate, junior @ fixed rate, senior is secured, junior is unsecured
What are the two types of junior debt?
High yield debt: public bond market or institutional market
Mezzanine debt: lowest ranking
What are the different payment methods for junior debt?
Bullet repayment (no amortization)
Cash
PIK
Combo
What does PIK stand for?
Paid-in-kind interests
How does PIK work?
“roll-up” interest that is not paid but added to face value of debt, paid in bullet at maturit
What is a bullet payment?
You pay the lump sum of your loan at the end
What are some additional debt instruments?
Bridge loans
Vendor financing
Shareholder loan
What are the different equity instruments?
Preferred shares
Common shares
Equity bridge
See the investment structures of LBO
andrea is a technoterrorist
What are the different LBO transaction documents?
NDA
Letter of Intent (LOI): starts setting out terms for negotiations in good faith (non-binding)
Sale and Purchase Agreement (SPA): main binding agreement w/ key dd findings, valuation, accounting and legal consideration, general terms and conditions for the transaction
What are the 2 steps of the SPA?
Signing: agree to conditions in SPA
Closing: terms and conditions come into force, PE acquires target
What are the common provisions?
Sale and Purchase: purchase price, closing time, location
Representation and warranties: statements of facts (risk goes to seller if it’s fake)
Covenants: commitment to take or avoid certain actions
Indemnifications: monetary penalties for contractual breaches
Condition Precedents (CPs): things that must be satisfied before sale
Material Adverse Change (MAC): right to terminate in case of material events
Termination rights and breakup fees: conditions allowing termination before closing
What are the capital commitment letters required for signing SPA
Debt Capital Letter (DBL): from investment bank to acquisition SPV
Equity Capital Letter (ECL): from PE fund to acquisition SPV
What is the necessary debt documentation?
Loan agreements (creditor and SPV)
Intercreditor agreements (rankings and rights among creditors)
What is the necessary equity documentation?
Articles of association (cash flow rights of shareholders)
Shareholder agreements (additional rights and obligation
How do you calculate the EBITDA Impact?
(EBITDA end - EBITDA start)*EV/EBITDA start
How do you calculate the Multiple Impact?
(EV/EBITDA end - EV/EBITDA start)*EBITDA end
What is the net debt impact?
Debt repaid using cash sweep => FCF
4 key credit statistics in an LBO
Total debt/EBITDA
Senior bank debt/EBITDA
EBITDA interest coverage
(EBITDA-CAPEX) interest coverage
ROI?
Equity value (LTM) - Equity Value (Exit)
CCM exit?
EV (exit)/ Equity (exit)
CFADS?
OCF-ICF
Cash available for optional debt?
Cash + OCF - ICF - cash sweep
