Leveraged Buyout (LBO) Model

• Estimates the value of a target company in an acquisition scenario using debt financing.

Procedures in Building Leveraged Buyout (LBO) Model

Step 1: Define the Transaction Assumptions

Before building the model, define key assumptions about the acquisition structure:

1. Purchase Price Assumptions

   • Entry Valuation: Determine the company's Enterprise Value (EV) based on EBITDA multiples, market price, or precedent transactions.
   • Equity Purchase Price: Calculate based on EV, net debt, and cash on the balance sheet.

2. Financing Structure (Sources & Uses)

   • Equity Contribution: The amount invested by the private equity firm.
   • Debt Financing: Different layers of debt (Senior Debt, Subordinated Debt, Mezzanine, etc.).
   • Fees & Transaction Costs: Investment banking fees, legal fees, financing fees, etc.

Step 2: Build the Financial Projections

Create a 5-7 year projection of the company's financial statements:

1. Revenue Growth Assumptions

   • Forecast based on historical performance, industry trends, and synergies.

2. Cost Structure & EBITDA

   • Project operating costs, margins, and capital expenditures (CapEx).
   • Estimate EBITDA, which is crucial for debt servicing.

3. Cash Flow Projections

   • Free Cash Flow (FCF) is key for debt repayment.
   • Consider working capital changes, CapEx, and interest expenses.

Step 3: Debt Schedule and Repayment

1. Interest Expense Calculation

   • Based on the different tranches of debt used in the buyout.
   • Some debt structures may allow for PIK (Payment-in-Kind) interest.

2. Debt Amortization

   • Determine repayment schedules for each tranche of debt.
   • Focus on mandatory and optional repayments (prepayments possible with excess cash flow).

3. Leverage Ratio Monitoring

   • Track Debt/EBITDA, Interest Coverage Ratio, and other key leverage metrics.

Step 4: Estimate Exit Value

After the investment horizon (typically 5 years), estimate the exit value:

1. Exit Strategy

   • Sale to a strategic buyer.
   • Secondary buyout (sale to another PE firm).
   • Initial Public Offering (IPO).

2. Exit Multiple Assumptions

   • Assume an exit EV/EBITDA multiple based on industry trends.
   • Exit value = EBITDA at exit × exit multiple.

Step 5: Calculate Investor Returns

1. Equity Value at Exit

   • Subtract remaining net debt from the exit enterprise value.

2. Internal Rate of Return (IRR) & Multiple on Invested Capital (MOIC)

   • Calculate IRR using the initial equity investment and exit proceeds: IRR=(Exit ValueInitial Investment)1Years−1IRR = \left(\frac{Exit\ Value}{Initial\ Investment}\right)^{\frac{1}{Years}} - 1IRR=(Initial InvestmentExit Value​)Years1​−1
   • MOIC (Money on Invested Capital): MOIC=Exit Equity ValueInitial Equity InvestmentMOIC = \frac{Exit\ Equity\ Value}{Initial\ Equity\ Investment}MOIC=Initial Equity InvestmentExit Equity Value​

Step 6: Sensitivity Analysis

• Perform scenario analysis by adjusting:
  • Exit multiples
  • Leverage levels
  • Revenue growth & margin assumptions
  • Debt repayment schedules
• Assess the break-even point and worst-case scenarios.