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Experienced in Leveraged BuyOut Model? Lbo model is the model that calculates the equity, debt and sales of any firm. This model works on the basis of the buyers selling the firm/target in future. The main objective of the Lbo model is that the to enable the investors to properly assess the transaction. Purpose of this model is to bring high returns on their equity investments. The debt/equity ratio is greater than two times the debt. Good knowledge on debt, sales, equity purpose are advantage to get the job. Wisdomjobs has interview questions which are exclusively designed for employees to assist them in clearing interviews. Lbo Model interview questions and answers are useful for employees who are good at sales and services.
"In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on Debt and other variables; 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, which 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 the new Debt and Equity figures, and also add in Goodwill & Other Intangibles on the Assets side to make everything balance.
In Step 4, you project out the company's Income Statement, Balance Sheet and Cash Flow Statement, and determine how much debt is paid off each year, based on the available Cash Flow and the required Interest Payments.
Finally, in Step 5, you make assumptions about the exit after several years, usually assuming an EBITDA Exit Multiple, and calculate the return based on how much equity is returned to the firm."
Purchase and exit multiples have the biggest impact on the returns of a model. After that, the amount of leverage (debt) used also has a significant impact, followed by operational characteristics such as revenue growth and EBITDA margins.
The same way you do it anywhere else: you look at what comparable companies are trading at, and what multiples similar LBO transactions have had. As always, you also 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.
"Ideal" candidates have stable and predictable cash flows, low-risk businesses, not much need for ongoing investments such as Capital Expenditures, as well as 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.
The most common example is taking out a mortgage when you buy a house. Here's how the analogy works:
First, the Liabilities & Equities side is adjusted - the new debt is added on, and the Shareholders' Equity is "wiped out" and replaced by however much equity the private equity firm is contributing.
On the Assets side, Cash is adjusted for any cash used to finance the transaction, and then 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.
Remember, these both represent the premium paid to the "fair market value" of the company. In an LBO, they act as a "plug" and ensure that the changes to the Liabilities & Equity side are balanced by changes to the Assets side.
It's a different scenario because:
1. The PE firm does not intend to hold the company for the long-term - it usually sells it after a few years, so it is less concerned with the "expense" of cash vs. debt and more concerned about using leverage to boost its returns by reducing the amount of capital it has to contribute upfront.
2. In an LBO, the debt is "owned" by the company, so they assume much of the risk, Whereas in a strategic acquisition, the buyer "owns" the debt so it is more risky for them.
Yes, there are shortcuts and you don't necessarily need to project all 3 statements.
For example, you do not need to create a full Balance Sheet - bankers sometimes skip this if they are in a rush. You do need some form of Income Statement, something to track how the Debt balances change and some type of Cash Flow Statement to show how much cash is available to repay debt.
But a full-blown Balance Sheet is not strictly required, because you can just make assumptions on the Net Change in Working Capital rather than looking at each item individually.
Usually you would look at Comparable LBOs and see the terms of the debt and how many tranches each of them used. You would look at companies in a similar size range and industry and use those criteria to determine the debt your company can raise.
This is completely dependent on the company, the industry, and the leverage and coverage ratios for comparable LBO transactions.To figure out the numbers, you would look at "debt comps" showing the types, tranches, and terms of debt that similarly sized companies in the industry have used recently.
There are some general rules: for example, you would never lever a company at 50x EBITDA, and even during the bubble leverage rarely exceeded 5-10x EBITDA.
This is a simplification, but broadly speaking there are 2 "types" of debt: "bank debt" and "high-yield debt." There are many differences, but here are a few of the most important ones:
• High-yield debt tends to have higher interest rates than bank debt (hence the name "high-yield").
• High-yield debt interest rates are usually fixed, whereas bank debt interest rates are "floating" - they change based on LIBOR or the Fed interest rate.
• High-yield debt has incurrence covenants while bank debt has maintenance covenants. The main difference is that incurrence covenants prevent you from doing something (such as selling an asset, buying a factory, etc.) while maintenance covenants require you to maintain a minimum financial performance (for example, the Debt/EBITDA ratio must be below 5x at all times).
• Bank debt is usually amortized - the principal must be paid off over time - whereas with high-yield debt, the entire principal is due at the end (bullet maturity).
Usually in a sizable Leveraged Buyout, the PE firm uses both types of debt.Again, there are many different types of debt - this is a simplification, but it's enough for entry-level interviews.
If the PE firm or the company is concerned about meeting interest payments and wants a lower-cost option, they might use bank debt; they might also use bank debt if they are planning on major expansion or Capital Expenditures and don't want to be restricted by incurrence covenants.
If the PE firm intends to refinance the company at some point or they don't believe their returns are too sensitive to interest payments, they might use high-yield debt. They might also use the high-yield option if they don't have plans for major expansion or selling off the company's assets.
Although technology is more "risky" than other markets, remember that there are mature, cash flow-stable companies in almost every industry. There are some PE firms that specialize in very specific goals, such as:
• Industry consolidation - buying competitors in a similar market and combining them to increase efficiency and win more customers.
• Turnarounds - taking struggling companies and making them function properly again.
• Divestitures - selling off divisions of a company or taking a division and turning it into a strong stand-alone entity.
So even if a company isn't doing well or seems risky, the firm might buy it if it falls into one of these categories.
Note that these are all "theoretical" and refer to the model rather than reality - in practice it's hard to actually implement these.
This means that the interest a firm pays on debt is tax-deductible - so they save money on taxes and therefore increase their cash flow as a result of having debt from the LBO.
Note, however, that their cash flow is still lower than it would be without the debt -saving on taxes helps, but the added interest expenses still reduces Net Income over what it would be for a debt-free company.
In a dividend recap, the company takes on new debt solely to pay a special dividend out to the PE firm that bought it.
It would be like if you made your friend take out a personal loan just so he/she could pay you a lump sum of cash with the loan proceeds.
As you might guess, dividend recaps have developed a bad reputation, though they're still commonly used.
Primarily to boost returns. Remember, all else being equal, more leverage means a higher return to the firm.
With a dividend recap, the PE firm is "recovering" some of its equity investment in the company - and as we saw earlier, the lower the equity investment, the better, since it's easier to earn a higher return on a smaller amount of capital.
No changes to the Income Statement. On the Balance Sheet, Debt would go up and Shareholders' Equity would go down and they would cancel each other out so that everything remained in balance.
On the Cash Flow Statement, there would be no changes to Cash Flow from Operations or Investing, but under Financing the additional Debt raised would cancel out the Cash paid out to the investors, so Net Change in Cash would not change.
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