An illustrative example of a paper LBO is provided below in 5 simple steps. In a paper LBO exercise, you will be expected to complete the important components of a working LBO model with the use of paper and pencil and without the use of a computer.
Using a 5. The given information assumes debt to equity ratio of for the purchase price. Also note that the numbers might not agree perfectly because of rounding. It is reasonable to round your intermediate calculations to the nearest integer in carrying over calculations to the next step. The following is the full paper LBO case study exhibit, calculated using Excel rather than pen and paper.
As a result, some of the numbers might be slightly different, as rounding has been eliminated:. If you catch a mistake part-way through, you will have to go back and correct it—sometimes causing you to have to recalculate nearly everything, and possibly leading to compounding mistakes on top of the original one. In addition, the interviewer will ask you to walk through your thought process and calculations.
Thus it is important to be able to build the proper paper LBO in simple, accurate steps, and make sure you can walk through the reasoning regarding the process and each calculation.
This takes practice, so be sure to practice at least one more paper LBO before your next private equity interview. The debt-to-equity ratio for the LBO acquisition will be Calculate the purchase price of ABC. Calculate the debt and equity funding amounts used for the purchase price.
Build the Income Statement. Subtract capital expenditures Capex. This is a standard assumption for a basic LBO model.In finance, a buyout refers to the purchase of a company's voting stock in which the acquiring party gains control of the target company. A buyout can be funded with a combination of cash or debt. Buyouts that are disproportionately funded with debt are commonly referred to as leveraged buyouts LBOs.
Private equity companies often use LBOs to buy and later sell a company at a profit. As the financial crisis of began, Hilton had major problems with declining cash flows and revenues. Safeway's board of directors gave consent to the buyout to avoid hostile takeovers from Herbert and Robert Haft of Dart Drug.
The deal was funded mostly with debt, and Safeway had to divest some of its assets and close unprofitable stores. InSafeway was taken public again with improvements in its revenues and profitability metrics. For related reading, see " 10 Most Famous Leveraged Buyouts ". Your Money. Personal Finance. Your Practice. Popular Courses. Compare Accounts.
The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Articles. Partner Links. Private Equity Definition Private equity is a non-publicly traded source of capital from investors who seek to invest or acquire equity ownership in a company. How Leveraged Buyouts Work A leveraged buyout is the acquisition of another company using a significant amount of borrowed money bonds or loans to meet the cost of acquisition.
Privately Owned Privately owned refers to businesses that have not offered shares to be traded on a public exchange. Institutional Buyout IBO An institutional buyout is the acquisition of a controlling interest in a company by an institutional investor.Debt comes in many different forms from credit cards, to loans, to mortgages.
It's a very important part of the business world and is used by both individuals and corporations. People can use debt to buy homes and cars, or to make everyday purchases without having to pay for them right away. This includes making acquisitions. These are called leveraged buyouts LBOs. Read on to find out more about LBOs and the most famous buyouts in business history.
The term leveraged buyout refers to the use of borrowed money to fund the acquisition of another company. Put simply, a company that takes on more debt to fund the cost of acquisition of another company is said to undergo a leveraged buyout.
LBOs are also commonly known as hostile takeovers because the management of the targeted company may not want the deal to go through.
Leveraged buyouts tend to occur when interest rates are low, reducing the cost of borrowing, and when a particular industry or company is underperforming and undervalued. The goal of leveraged buyouts is to make a large acquisition without committing much capital investment. The desired result of combining the two companies is the creation of one stronger, more profitable entity that better maximizes shareholder value.
LBOs may be done to help a public company transition to a private one, to sell off a segment of a business, or to transfer private property from one entity to another. The deal was based on the belief that rising demand for energy would stretch supply and push up electricity prices. Shortly after the deal was completed, increased horizontal drilling, or frackingled to the U. The newly-founded company, Energy Future Holdings, filed for Chapter 11 bankruptcy inqualifying as one of the 10 biggest nonfinancial bankruptcies in history.
When the economy slumped into crisis soon after the deal was struck, it appeared it could not have picked a worse time, especially when some of its partners—Bear Stearns and Lehman Brothers —fell apart. Things turned around drastically when the company went public infamously transforming the Hilton deal into the most profitable private equity deal ever.
InBlackstone sold its stake in the hotel chain. The private equity firm unloaded In a deal that got messy, the private equity firms involved went to court to force the banks to complete the largest buyout in the media and entertainment industry. Inthe company changed its name to iHeartMedia, Inc.
The Houston-based pipeline operating company Kinder Morgan agreed to a buyout offer from a group of investors led by its chairman and co-founder, Richard Kinder. In a story full of twists and turns, shareholders sued, believing Kinder kept the deal a secret from his own board. The deal was highly criticized for the abundance of conflicts of interests.
Having only advised the company previously, Goldman Sachs became part of the investment group that helped Richard Kinder complete the deal to buy his own company. The company was taken public in in the largest American private equity-backed initial public offering IPO ever. Decades later, the RJR Nabisco deal of is still the most iconic and famous private leveraged buyout of all time. The deal was so groundbreaking, it was the inspiration for a book and successful movie, both titled "Barbarians at the Gate.
The acquisition of the former Motorola property is famous for being the largest leveraged buyout of a technology firm in history. The company almost did not survive after severely underestimating its debts but rose from the ashes with a IPO.LBO analysis helps in determining the maximum value that a financial buyer could pay for the target company and the amount of debt that needs to be raised along with financial considerations like the present and future free cash flows of the target company, equity investors required hurdle rates and interest rates, financing structure and banking agreements that lenders require.
There are a lot of Speculations about it. Will it take place? Will it not? Such is the hype of Leveraged Buyouts today. LBO sounds like a dense word and indeed it is. So why exactly is the hustle and bustle about the word LBO? Leveraged buyout LBO is very similar to buying a house. Suppose you want to buy a big house what will you do? You will put down some money as cash and go for a loan for the remaining amount. And most of the times loan forms a major part of the entire transaction.
Similar is the concept in Leveraged Buyout. In a Leverage buyout LBOyou acquire a company or part of a company. But this is a common thing which you may have heard. Yes, remember that Debt forms a major part of an LBO transaction.
Now coming to the parties involved in the LBO deals. There is a Buyer and the Target company. The Buyer mostly is a private equity fund that invests a small amount of equity and majorly uses leverage or debt to fund the remainder of the consideration. Thus, the main point to concentrate here is, the acquisition of another company is significantly by borrowed money bonds or loans to meet the cost of acquisition. The Private Equity firm uses debt to lift its returns. Using more debt means that the PE firm will earn a higher return on its investment.
We will see how this happens in the latter part of this article. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital. During that period several prominent buyouts led to the eventual bankruptcy of the acquired companies. You will then properly understand why LBO was opted by that firm. So to give you a gist…. And this is the reason why LBOs can be sometimes regarded as ruthless and a predatory tactic.When interviewing for a junior private equity position, a candidate must prepare for in-office modeling tests on potential private equity investment opportunities—especially LBO scenarios.
In this module, we will walk through an example of an in-office LBO modeling test. In-office case studies and modeling tests can occur at various stages of an interview process, and additional interviews with other members of the private equity team could occur on the same day.
Make sure to take your time and build every formula correctly, since this process is not a race. There are many complex formulas in this test, so make sure you understand every calculation.
This type of LBO test will not be mastered in a day or even a week.
Leverage Buyout | LBO Analysis
You must therefore begin practicing this technique in advance of meeting with headhunters. Repeated practice, checking for errors and difficulties and learning how to correct them, all the while enhancing your understanding of how an LBO works, is the key to success. We will use it as an example of how to build an LBO model from scratch during the interview.
Remember that candidates will receive a laptop and a printout with key information regarding the transaction to complete this assignment. ABC Company, Inc. The company sells two products for the various smartphones. The first is a software application called Cloud that tracks weather data.
ABC Company sold 1. That was the first year ABC Company generated any revenue. Note that ABC Company does not incur any additional costs for renewals. Due to the depressed macroeconomic and investing environment, the PE fund is able to acquire ABC Company for the inexpensive purchase price of 5. The transaction is expected to close at the end of Hint: The first forecast year for the model will be However, you will need to build out the income statement for and to forecast the financial statements for years through Note that the above description incorporates all of the information, assumptions and assignments that were given in this LBO in-person test example.
As part of the first step, build out the core operating Income Statement line items for years through As part of the second step, build out the transaction summary section which will consist of the Purchase Price Calculation, Sources and Uses, and the Goodwill calculation.
Private Equity Paper LBO Example (Standard) – A Step-by-Step Walk-Through
As a next step, build out the Pro Forma Balance Sheet using the given balance sheet. To do this, you need to incorporate all the transaction and financing-related adjustments needed to produce the Pro Forma Balance Sheet.
Each adjustment is discussed in detail below. Next, build the full Income Statement projections all the way down to Net Income.
Note that a few line items especially Interest Expense! Once the Cash Flow section and other schedules are built, link all the final line items to complete the integrated financials. Next, forecast the Balance Sheet from to Note that this model is less complex than it could be.
Given that Capital Expenditures do not change each year, and that each new Capital Expenditure is depreciated according to the same simple schedule, the numbers and calculations are fairly straightforward. In the final step of the LBO test, build out the Returns calculation required in the Exercises section.There, we lay out the structure you should follow along with tips to avoid the common mistakes.
You can find that article here. Exit at the end of Year 5 with the same multiple as at entry. This is a recurring theme in private equity interviews. They expect you to have a structured thought process and not be all over the place.What is Leveraged Buyout (LBO)?
The purpose of this step is to calculate the Entry Equity Check. Second, project out Levered Free Cash Flow. This step gives you the numbers i. First, calculate the Enterprise Value.
10 Most Famous Leveraged Buyouts
The interviewer just told you that the deal is being financed with 4x bank debt and 2x bond. The interviewer had told you that you enter at the end of year 0 and exit at the end of Year 5. First, it takes up valuable interview time, time that you need to show that you can think like an investor. Second, it increases your chances of messing up. And confirm with interviewer that you can round the numbers to the nearest whole number.
While you can sacrifice calculating other line items i. Do this so that the interviewers can follow your math. Finally, subtract Taxes to get Net Income. So it should look like this:. This is one of the key parts of any LBO. Remember what we said about simple math above? Second, subtract out Capital Expenditures.
So the net impact from these two steps is zero. Finally, adjust for Changes in Working Capital. Working Capital needs usually mean negative cash flow impact.
First, calculate the Exit Enterprise Value. At the same time, all the Levered Free Cash Flow accrued to your balance sheet. This means that at exit, your cash balance is the sum of the Levered Free Cash Flow over the 5-year period.
Yes, you absolutely need to memorize this. The standard private equity holding period is 5-years so most interviewers expect you to know it.
A MOIC of 3. The investment is 2. So the IRR must be slightly above Now that you have went through the above paper LBO example, try to create a prompt like the one we laid out above on your own.
Change the numbers a bit and then practice it yourself based on our proposed structure. We recommend that you get to a level where this is second nature to you before you walk into the interview.
The above paper LBO example is a standard problem set. See why you should work with us for your PE recruiting process here. Shaw, Citadel, etc.So developing this instinct and judgment on your own and searing it into your brain is critical.
You might be allowed to use a calculator, but you might not. You can end up with results that make no sense. PE Capital is considering a purchase for 5. PE Capital plans to use all excess free cash to pay down principal.
It might have lots of extraneous information. The point is, it can take lots of different forms. To use your time efficiently, I strongly urge you to work backward. Burn that formula into your BRAINbecause you are going to ruthlessly solve for each piece of that formula. The most computationally intensive piece is by far the remaining debt amount after 5 years.
That will always be the variable that takes the most arithmetic to solve. Since we know the debt vs. Because, even if we did nothing during the time we own the company, as long as we paid a FAIR price for it, we should be able to assume the next buyer will also pay a fair price for it — as reflected in the purchase multiple.
Remember: no calculators. Decimals make my head want to explode. My head wants to explode. Now you have revenue estimates for 5 years. Now we just need to know how much debt is left at the end of Year 5 to calculate our multiple-of-money return. With our EBITDA numbers in place, we now have to compute annual free cash flow to determine how much debt to pay down each year. Finally, computing CapEx and net working capital is straightforward.
Being able to work quickly, accurately, and efficiently with pencil on paper, and without having to rely on a calculator, is a very critical skill. Repeating the computation process for each remaining year, and rounding to whole numbers where appropriate, leaves us at the end of Year 5 with:.
There might be other places to deploy capital that will yield a higher risk-adjusted return — especially considering that private equity is pretty much illiquid until the fund retires. Based on personal experience, a 3. And to hit a 3. Whether through one of these methods or a combination of them, the truly value-added PE investors, the top-quartile ones, will proactively grow EBITDA beyond organic levels.
It shows your interviewer you not only have a strong grasp of the financial analytics. But you also see the big picture of where private equity returns come from: how much from organic lift, how much from leverage, how much from operational improvements, how much from multiple expansion, etc.