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Contents
LBO Short Form Modeling1

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Disclaimer
Edition 2021
Copyright Adkins Matchett & Toy Limited
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© AMT Training 2008–2021 F

LBO Short Form Modeling

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LBO Short Form

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Modeling Coc
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 LBO Short Form Modeling

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LBO Short Form Modeling

LBO analysis fundamentals

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Summary

• LBO overview
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• LBO valuation
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• LBO short form model (lite)

• LBO financing

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 LBO Short Form Modeling

LBO overview

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What is a leveraged buyout?

Overview

Objective Characteristics
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Financial buyers purchase assets, Transaction is typically

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with the objective to sell them in the highly leveraged, hence

short to medium term, for a substantial LBO
profit
Returns driven by
deleveraging and improving
operating performance

Investment horizon 3 to 5
years

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LBO Short Form Modeling

Impact of high leverage

High leverage gives additional equity returns but at an additional risk

Advantages Disadvantages

Equity returns can be enhanced by Higher fixed interest costs increase

Returns high leverage Volatility earnings and cash flow volatility

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Fiscal
Interest expense is generally a tax- Default Higher leverage results in higher
deductible expense risk default risk

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High leverage increases default risk,
Discipline forcing business efficiency
Reduced Less strategic and financial flexibility
flexibility due to stressed balance sheet
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Drivers of the LBO market

• Asset valuations
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– When companies are highly valued, it is harder to invest today and make a high return
over the investment period
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• Amount of private equity funding available

– PE firms are more active in the market, and may pay higher prices, when investors are
willing to contribute more to funds
• Availability of credit
– The appetite of debt investors drives the leverage available for transactions. This in turn
can drive equity returns higher
• Interest rates
– Lower interest rates mean companies can support higher levels of debt

5 © AMT Training 2008–2021

 LBO Short Form Modeling

LBO valuation
How to turn an LBO analysis into a valuation method

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LBO analysis
The steps
• Calculate offer enterprise and equity value
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– Frequently done using an EBITDA multiple

• Sources and uses of funds at entry
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– Identify the potential financing structure for the transaction

• Forecast operating performance
– Forecast cash flows available for debt repayment
– Enables estimation of the amount of debt at exit
• Sources and uses of funds at exit
– Estimated sale price and debt at exit
– Estimate exit equity value
• Calculate the returns to investors
– Calculate the annualized ROE using an internal rate of return (IRR) calculation

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LBO Short Form Modeling

LBO analysis

Example Answer
Entry Case 1 Case 2
Assumptions: Repay Improve
debt margins
– A PE firm purchases Rex Co for too
7.0x its EBITDA of 100
EBITDA multiple 7.0x 7.0x 7.0x
– The deal is financed with 30%

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EBITDA 100 100 120
equity and 70% debt
EV 700 700 840
– Exit year 4, no multiple expansion Debt 490 350 350
– Case 1 – repay debt down to 350 Equity 210 350 490

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– Case 2 – improve EBITDA to 120 ROE / IRR
and repay debt down to 350
Co ROE / IRR 13.6% 23.6%

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LBO analysis
Drivers of return

• Debt repayment
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– Enterprise value stays constant, but equity value rises as debt is repaid
• Margin enhancement (cost cutting and efficiency improvements)
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– Enterprise value increases, debt stays constant or maybe repaid and equity value rises
• Acquisition and sale multiples are assumed constant (no multiple expansion)
– Entry and exit multiples are constant

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LBO analysis as a valuation method

LBO valuation indicates the maximum price a financial buyer can pay

Assume offer price

The offer Enterprise

Adjust offer price to value (EV) is calculated

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reach minimum IRR for • EV / EBITDA typically used
financial sponsor

Sponsor returns

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The higher the offer measured
value, the lower the IRR • IRR
for the financial sponsor • Money multiple
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Impact of entry value on investor returns

As entry price increases, investor returns decrease

Entry analysis Exit analysis

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Entry price Low Medium High Entry price Low Medium High
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Entry multiple 6.0x 7.0x 8.0x Exit multiple (1) 7.0x 7.0x 7.0x
EBITDA (Year 0) 200 200 200 EBITDA (Year 3) (2) 220 220 220
Enterprise value Enterprise value
Debt / EBITDA 5.0x 5.0x 5.0x Debt value (3) 800 800 800
Debt financing Equity value
Equity financing IRR

As the price paid at entry increases, it is unlikely that the At exit, the IRR of the investment is driven by the exit
amount of debt available will increase. enterprise value and the equity financing at entry. The
As a result the investor needs to increase their amount higher the entry equity financing the lower the
of equity financing at entry investment IRR

(1) Exit multiple benchmarked against trading and transaction multiples

(2) Exit EBITDA increase driven by sales growth and efficiency improvements
(3) Cash generation and debt repayment not affected by price paid at entry
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LBO Short Form Modeling

What makes a target firm a good LBO candidate?

• Asset at ‘reasonable’ price

• Realistic exit route

Price
• Opportunity for operational
improvements

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Cash •
•
Good management team
Strong market position

• Stable, predictable cash Growth

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flows support leverage
• Good cash conversion ratio
• Limited investment required
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Exit routes
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Sale to strategic Initial Public Secondary /

Recapitalization
buyer (‘trade sale’) Offering (IPO) Tertiary exit
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• Typically 100% is • Often less than • Business is • Business is sold

sold 50% is sold refinanced and to another
• Sold post turn- • Often run as part re-leveraged financial sponsor
around initiatives of a ‘dual track’ • Allows partial
implemented by process where cash-out for the
the financial an M&A deal is equity investors
sponsors pursued at the via special
• Strategic buyers same time dividend
can typically pay • Does not allow
for synergies liquidation of the
control premium

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LBO short form model (lite)

Simple operating forecast

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Basic financing structure

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LBO short form model output

Key outputs

• How much debt can the target business support?

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– A given set of operational forecast will determine the cash flows available to repay debt,
hence identifying the maximum debt capacity
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• What is the likely capital structure for the transaction?

– Having established the total debt capacity, the financing instruments used to fund the
deal need to be identified and quantified
• What is the maximum price that the buyer might be willing to pay?
– Identifying a minimum internal rate of return (IRR) for the equity investors will establish
the maximum price that can be paid

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LBO short form model output

The financial investor

will normally target a

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return of between
20% and 25%

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LBO short form model steps

Step 1: Calculate offer enterprise and equity value

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Step 2: Sources and uses of funds at entry

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Step 3: Forecast operating performance

– Operating forecast
– Cash flow statement
– Debt schedule
– Wiring up interest
– Debt analysis
Step 4: Sources and uses of funds at exit
Step 5: Calculate the returns to investors
– Equity returns and MOIC
– Sensitivity analysis

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Circularity settings Danger! Building a model with the circular switch on and
iterations active can result in unintentional circularities!

Model construction Financial model analysis

Enable Enable
Switch iterative iterative Circular switch
calculations calculations

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Off Off On On

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Set to Set to
No tick Tick
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Step 1: Calculate offer enterprise and equity value

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All outstanding
options

Latest available
shares outstanding

LTM numbers provide the latest

available historical benchmark

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LBO Short Form Modeling

Step 2: Sources and uses of funds at entry

The table of sources and uses of funds shows the capital structure for the
transaction
– The uses of funds are the purchase price, the refinanced debt and the fees
– The sources of funds are made up of the financing of the deal (debt and equity)
– The amount of debt financing depends on the cash flow generation of the business, and
on the availability of credit:

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• Start with a preliminary assumption on the amount of senior and subordinate debt
• The % of total calculation and the D / EBITDA multiple can be used as sanity-checks
– The equity contribution is the plug that makes the table balance

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– The interest rate on debt can be calculated at this stage
• Floating rate debt is calculated as a margin over the reference rate
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Step 2: Sources and uses of funds at entry

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Step 3: Forecast operating performance

The private equity house / management will prepare an operational forecast

Income statement Balance sheet

• Last twelve months (LTM) earnings • A full balance sheet forecast is not
are an important historical necessary
benchmark • Only the operating items that have a
• Operating improvements (e.g. material cash flow impact are needed

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profitability increases) are often • Off-balance sheet financing might have
included in the forecasts to be considered (e.g. pension deficits)
• Improvements to OWC ratios and
• The interest calculation is left blank

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‘capex holidays’ (in the early years
at this stage post deal) should be considered
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Step 3: Forecast operating performance

Build operating model forecast
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Operating assumptions drive

operating model

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LBO Short Form Modeling

Step 3: Forecast operating performance

Cash flow statement
• To establish the debt capacity of the
target business, the cash flow
available for debt repayment has to
be quantified
• The operations generate cash
flows, which are used to make

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operating investments (working
capital, capex, etc.) and to pay tax
and interest. Any excess cash will
be used to repay debt

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• The interest expense lines should
be left blank at this stage
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Step 3: Forecast operating performance

Debt schedule

• The debt schedule calculates the

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ending balance of the debt for each

year. The initial amounts are
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anchored to the sources of funds

• The repayment line is to be left
blank, until the cash flow statement
is complete
• Interest should be calculated on
average balances

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Step 3: Forecast operating performance

Debt repayment calculation

• The debt repayments can now be

calculated
• MIN functions must be used to
avoid over-repaying
• The senior debt takes priority over

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the subordinated debt
• Once calculated in the cash flow
statement, link the repayments to

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the debt schedule

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Step 3: Forecast operating performance

Wire up interest: cash flow statement and income statement
• Wiring up the interest into the
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income statement and cash flow

statement creates a circularity
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• At this stage, the iteration box in

Excel's settings must be switched
on
• The interest calculations must be
linked into the cash flow statement
first, using an IF statement that
references the circularity switch
• Lastly the interest can be linked into
the income statement

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LBO Short Form Modeling

Debt analysis
Ratios
• Leverage and coverage ratios should
be calculated
• Debt ratios are used to analyse the
development of the financial structure
in time, and are also useful to compare
this transaction to other deals

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• Debt ratios are used to establish
covenants designed to protect the
lenders

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• The IFERROR function should be used
to prevent the ratio calculations
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Debt analysis
Average life
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• The repayment of the senior debt is not ‘straight line’.

The average life calculates the maturity of an
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equivalent ‘bullet’ loan

• Each repayment is multiplied by the year number and
the sum of the weighted repayments is then divided
by the original loan amount
• The = SUMPRODUCT (range of years,range of
repayments) function simplifies this calculation

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Debt analysis
Repayment year

• Term A amortizes over 7 years, term B must be repaid in year 8 and term C
in year 9
• If the debt is not repaid in full before its maturity, the firm is taking refinancing
risk
• The subordinated debt in this model has a 10-year maturity

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• The COUNTIF function will check if the debt is repaid timely

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Step 4: Sources and uses of funds at exit

Equity value calculation

• The enterprise value at the end of

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each forecast year can be

calculated by multiplying the
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assumption for the exit EV /

EBITDA multiple by the EBITDA
forecast
• The equity value is calculated at the
end of each forecast year using the
forecast EV and the bridge from EV
to equity value for that date

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LBO Short Form Modeling

Step 5: Calculate the returns to investors: IRR

• The internal rate of return for equity

holders depends on the initial
investment, and on the value of the
equity at exit
– Use the cash flows to equity
holder’s line to show these values

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• The IRR is calculated using the IRR
function in Excel
• The XIRR function can also be

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The negative cash flow in year 0 is the initial equity
used if you wish to specify the investment (from the sources of funds).
For years 1 to 10, an IF statement is used to show a
dates of the cash flows Co positive cash flow in the exit year

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Step 5: Calculate the returns to investors: MOIC

• Money on money or multiple on

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invested capital (MOIC), is one of

the most fundamental performance
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measurements for private fund

investing
• Sometimes called TVPI (total value
to paid-in) or the investment
multiple, MOIC is calculated by
dividing the sum of a fund's realized
and unrealized value by the total
amount invested

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Step 5: Calculate the returns to investors

Sensitivity analysis

Overview One input, multiple output data table

• For a comprehensive analysis of

the deal, the model outputs should
be sensitized against changes in
the main inputs

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• Build a data table that shows the
sensitivity range for the input
variable, and the corresponding
values for the desired outputs

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• The offer price or premium paid is
one of the inputs that should always
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LBO financing
The financing structure

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LBO Short Form Modeling

Setting up the financing structure

Sources and uses of funds

Sources Uses

• Cash • Purchase of targets equity

– Excess cash from target balance • Retire existing target debt
sheet • Transaction fees and expenses
• Debt

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• Cash to target balance sheet
• Equity – Working capital requirements

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Setting up the financing structure

• Financial sponsors aim to maximize the amount of debt used in the

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acquisition, and minimize the equity

• This is achieved through:
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– Creating debt products whose terms are tailored to the needs of debt investors
– Tapping into different segments of the credit market
– Allocating debt within the corporate structure according to a ‘structural subordination’
logic
– Liquidity to operate the business
• Reach out to capital markets and internal credit teams for input on likely
financing structure

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The term structure of LBO financing

• Extending the term (maturity) of the financing increases the debt capacity of
a business
– Borrow against cash flows further and further out in time
• For the lender, extending the term increases risk
• The term profile of an LBO financing structure is built in order of seniority

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– The more senior the debt, the earlier the cash flow claim, the shorter the debt maturity

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LBO financing
Sources of funds in detail; term structure
• Term Loans
Senior secured debt
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Can be split into tranches (e.g. A, B, C), Maturity 7 years

• Second lien
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Senior secured debt

Maturity 8 years Maturities are
illustrative
Senior unsecured • High yield bonds
debt Maturity 8 years
• Mezzanine finance
Subordinated debt
Maturity 8 years
• Other subordinated debt
Other debt
Maturity 8 years
• LBO sponsor, Existing shareholders, Management
Equity
Targeted return c. 20% IRR

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Debt instruments
General characteristics
• Amount borrowed and principal
• Cost: interest
– Cash interest vs PIK interest
• Repayment date: maturity date
– Bullet repayment vs amortizing
• Security: collateral
– Secured vs unsecured

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– 1st lien vs 2nd lien
• Priority of payment: seniority
– Senior vs junior; subordinated vs unsubordinated
• Covenants

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• Op Co. vs. Hold Co.
• Other features (convertible, callable, cum-warrants etc)
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Common covenants
Credit ratios act as early warning system; Ratios monitored

Coverage ratios Leverage

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• EBITDA / Interest expense • Senior debt / EBITDA

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• (EBITDA – Capex) / Interest • Net debt / EBITDA

expense • Total debt / EBITDA
• FCF / Total debt

Whilst these covenants are typically used,

remember that EBITDA does not equal FCF

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Senior secured debt

Cost of senior debt

Typically split into tranches Cost of senior debt

Term Maturity Repayment Spread • Lowest cost debt because of lower
A 6 yrs Amortizing 300 risk due to:
B 7 yrs Bullet 400
– Security
C 8 yrs Bullet 500
– Covenants

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– Ranking
Indicative spread
over reference • Floating interest rate
rate
– Often partly swapped into fixed rate

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Senior secured debt

Second lien

• Helps to extend secured debt and therefore reduces the overall cost of
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funding
• Floating interest rate, bullet repayment
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• Secured via a second ranking fixed charge

– ‘Lien’ is a legal word that means a security charge like a mortgage
– The lender only gets what is left over after the first ranking charge has been satisfied (the
revolving credit facility and term loans)
• Minor financing source
• Investor base is primarily hedge funds

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Senior secured debt

Establishing the senior debt capacity of the target

Cash flow lending EBITDA multiple as a proxy

• The maximum debt capacity can be • EBITDA is often used as a quick-

estimated using cash flow and-dirty benchmark for cash flow
projections and some financing – Debt financing is often quoted as a
assumptions multiple of EBITDA

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• LTM EBITDA used as key reference
• Cash flow available for debt
point
servicing is calculated
• EBITDA measures earnings not
– The cash flow that can be used to cash flow

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repay the principal plus the interest
– Check cash conversion ratio: FCF /
– Equal to the free cash flow (FCF) NOPAT
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Senior unsecured debt

High yield debt

Features Advantages / Disadvantages

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• High yield debt sold • Advantages

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– In the public markets via bonds; or – More flexible

– Can be placed via private – Less restrictive covenants
placement to specific bond (incurrence basis)
investors (under rule 144A) – No amortization
• Typically minimum size of $100m / • Disadvantages
£100m / €100m – Higher cost
– Usually cannot be called until after
3 – 5 years

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Subordinated debt
Mezzanine debt

Features Advantages / Disadvantages

• Interest may be PIK • Advantages

• Sometimes with warrants attached – Few covenants
• Return measured as an internal – Maximizes leverage
rate of return – PIK allows cash to be conserved

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– a blend of the return on the loan • Disadvantages:
plus the value of the warrants – Significantly higher cost
– typically mid-teens, but will vary

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– Dilution of equity returns
through the cycle • Via warrants
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Equity
The equity contribution is split between two components

• 25% – 40% of total capital (1)

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• Split is primarily driven by the need to incentivize management

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– Preferred stock (or shareholder / vendor loan notes)

• Institutional investors
• Usually PIK dividends
– Common stock
• Institutional investors and management
• Often pays no dividends (prevented by debt covenants)
• Target IRR for institutional investors c. 20% (1)

(1) Market currently sees deals with equity up to 50% and target IRR at 15 to 20%

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LBO Short Form Modeling

Structural subordination
Debt push down

• Debt investors want to be as close

Parent company
as possible to the operational cash
flows • Sponsor equity
• Prefer to lend to operating • Management equity
companies if possible Holding company

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• If not possible will lend to holding
companies which receive dividends • Subordinated debt
from the operational business
Operating company

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• Equity investors will invest at the
parent company level • Senior unsecured debt
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LBO overview
Appendix

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Solution: Impact of entry value on investor returns

As entry price increases, investor returns decrease

Entry analysis Exit analysis

Entry price Low Medium High Entry price Low Medium High
Entry multiple 6.0x 7.0x 8.0x Exit multiple (1) 7.0x 7.0x 7.0x
EBITDA (Year 0) 200 200 200 EBITDA (Year 3) (2) 220 220 220
Enterprise value 1,200 1,400 1,600 Enterprise value 1,540 1,540 1,540

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Debt / EBITDA 5.0x 5.0x 5.0x Debt value (3) 800 800 800
Debt financing 1,000 1,000 1,000 Equity value 740 740 740
Equity financing 200 400 600 IRR 54.7% 22.8% 7.2%

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As the price paid at entry increases, it is unlikely that the At exit, the IRR of the investment is driven by the exit
amount of debt available will increase. enterprise value and the equity financing at entry. The
As a result the investor needs to increase their amount higher the entry equity financing the lower the
of equity financing at entry investment IRR

(1)
(2)
(3)
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Exit multiple benchmarked against trading and transaction multiples
Exit EBITDA increase driven by sales growth and efficiency improvements
Cash generation and debt repayment not affected by price paid at entry
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Please note:
All materials are the intellectual property of AMT Training. Please visit us on: www.amttraining.com
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LBO Short Form Modeling

LBO short form model

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Contents

• LBO short form model overview

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• Short form model steps

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– Sources and uses of funds at entry

– Operating scenarios
– Cash sweep modeling
– Debt ratios
– Sources and uses of funds at exit
– Disaggregating returns
• Appendix: LBO Financing

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LBO short form model overview

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Short form or long form analysis?

Short form Long form

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• Preliminary assessment of the • Full and detailed analysis of

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maximum price that a financial – Maximum price that a financial

buyer can pay for the target buyer can pay
• Typically used for an initial analysis – Deal financing structure
(e.g. pitching)
– Investors returns
• Can use a simplified or more
complex financing structure – Likely covenants structure
• Only key items are forecasted (the • Typically used for live deals
model does not have complete • Complex and time-consuming
financial statements)

© AMT Training 2008–2021 30

LBO Short Form Modeling

LBO analysis
The steps
• Calculate offer enterprise and equity value
– Frequently done using an EBITDA multiple
• Sources and uses of funds at entry
– Identify the potential financing structure for the transaction
• Forecast operating performance
– Forecast cash flows available for debt repayment

se
– Enables estimation of the amount of debt at exit
• Sources and uses of funds at exit
– Estimated sale price and debt at exit

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– Estimate exit equity value
• Calculate the returns to investors
– Calculate the annualized ROE using an internal rate of return (IRR) calculation
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LBO short form model

Operating forecast scenarios
Detailed financing structure

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LBO short form model output

Key outputs

• How much debt can the target business support?

– A given set of operational forecast will determine the cash flows available to repay debt,
hence identifying the maximum debt capacity
• What is the likely capital structure for the transaction?
– Having established the total debt capacity, the financing instruments used to fund the
deal need to be identified and quantified

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• What is the maximum price that the buyer might be willing to pay?
– Identifying a minimum internal rate of return (IRR) for the equity investors will establish
the maximum price that can be paid

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LBO short form model steps

Step 1: Calculate offer enterprise and equity value

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Step 2: Sources and uses of funds at entry

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Step 3: Forecast operating performance

– Operating forecast scenarios
– Cash flow statement
– Detailed debt schedule
– Cash sweep modeling
– Debt analysis
Step 4: Sources and uses of funds at exit
Step 5: Calculate the returns to investors
– Equity returns and MOIC
– Disaggregating returns

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Circularity settings Danger! Building a model with the circular switch on and
iterations active can result in unintentional circularities!

Model construction Financial model analysis

Enable Enable
Switch iterative iterative Circular switch
calculations calculations

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Off Off On On

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Set to 0 No tick Co Tick Set to 1
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Step 1: Calculate offer enterprise and equity value

• Offer price assumption may be based on a % offer premium above the stock
T

market price, or on a multiple of earnings

– Public deals are likely to be priced using a premium
AM

– Private deals will be priced based on an EV multiple

– A ‘switch’ cell can be used to switch between these two methods
• Up-to-date financial information for the target should be used
– Number of shares outstanding and dilutive instruments (e.g. options)
– Last twelve month’s earnings

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Step 1: Calculate offer enterprise and equity value

Switch cell can be used to
change between premium
and multiple driven pricing

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IF function used to
change valuation
calculation

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Conditional formatting is
used to grey out unused
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Step 2: Sources and uses of funds at entry

The table of sources and uses of funds shows the capital structure for the
T

transaction
– The uses of funds are the purchase price, the refinanced debt and the fees
AM

– The sources of funds are made up of the financing of the deal (debt and equity)
– The amount of debt financing depends on the cash flow generation of the business, and
on the availability of credit:
• Start with a preliminary assumption on the amount of senior and subordinate debt
• The % of total calculation and the D / EBITDA multiple can be used as sanity-checks
– The equity contribution is the plug that makes the table balance
– The interest rate on debt can be calculated at this stage
• Floating rate debt interest is calculated using a margin over the reference rate

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Step 2: Sources and uses of funds at entry

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Step 2: Sources and uses of funds at entry

Why have two types of equity?

• If only one type of equity is used,

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management may be incentivised

to induce a fire sale
AM

• By using two types of equity, the

institutional investor ensures it
makes a minimum return before the
management benefit from their
investment
– Management would not be
incentivised to induce a fire case

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Step 2: Sources and uses of funds at entry

Multiple financing scenarios

Multiple capital structures can be incorporated into an LBO model when

considering different financing scenarios

Enter as many capital

structure choices as you
need. This example shows

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four capital structures

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Use INDEX to return
the specified choice.
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Step 3: Forecast operating performance

The private equity house / management will prepare an operational forecast

Income statement Balance sheet

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• Last twelve months (LTM) earnings • A full balance sheet forecast is not
AM

are an important historical necessary

benchmark • Only the operating items that have a
• Operating improvements (e.g. material cash flow impact are needed
profitability increases) are often • Off-balance sheet financing might have
included in the forecasts to be considered (e.g. pension deficits)
• Improvements to OWC ratios and
• The interest calculation is left blank
‘capex holidays’ (in the early years
at this stage post deal) should be considered

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Step 3: Forecast operating performance

Build operating model forecast

• Operating scenarios allow

assumptions and methodologies to
be changed quickly in models
• There are various switch functions
that allow this to be set up. The
main ones are:

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– CHOOSE
– OFFSET

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– INDEX
– MATCH
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Step 3: Forecast operating performance

Build operating model forecast
T
AM

Selected case assumptions drive

operating model

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Step 3: Forecast operating performance

Cash flow statement
• To establish the debt capacity of the
target business, the cash flow
available for debt repayment must
be quantified
• The operations generate cash
flows, which are used to make

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operating investments (working
capital, capex, etc.) and to pay tax
and interest. Any excess cash will
be used to repay debt

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• The interest expense and debt
repayment lines should be left
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Step 3: Forecast operating performance

Cash sweep definitions
Item What does it mean? How is it calculated?
T

Cash flow available for debt The total cash generated by the CFO plus
repayment business during the year that is CFI plus
AM

available to repay debt principal Any equity cash flows included in

CFF
Cash available for debt The total cash available to repay Beginning cash, plus cash flow
repayment debt at the end of the period, after available for debt repayment,
holding back any cash for minus minimum cash needed for
operating purposes operations
Mandated repayments Debt repayments that are Forecast as part of a cash sweep
required this year
Accelerated repayments Optional and early repayments of Forecast as part of a cash sweep
debt

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Step 3: Forecast operating performance

The waterfall: Cash sweep with mandated debt repayments
Cash flow Cash available
available for for debt
debt repayment repayment

Mandated
Beginning cash repayments of
long-term debt
Less operating

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cash Revolver
requirement

Accelerated

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repayments of
long-term debt

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Step 3: Forecast operating performance

Cash available for debt repayment
T

The total cash available to

Cash available for debt
repay debt at the end of the
repayment period
AM

Cash flow
Operating cash
available for debt Beginning cash
requirement
repayment

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Step 3: Forecast operating performance

Calculating the long-term debt mandated repayments

• The mandated repayments are

tested against the actual debt
balances to check whether they
need to be made
• Cash is held back to make these
payments first

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Mandated LT debt
repayment

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Actual mandated
Lower of
repayment made

Beginning LT debt
balance Co
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Step 3: Forecast operating performance

Cash available after mandated debt repayments

Cash available after mandated debt

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repayments is calculated by deducting

the mandated repayments made from
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the cash

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Step 3: Forecast operating performance

Calculating the short-term debt requirement
The revolver balance is forecast using a
BASE analysis
Beginning
Add Issuance
Subtract Repayment
Ending

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Cash available after
mandated debt
repayments

Change in revolver

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Lower of
balance

Beginning revolver
balance Co
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Step 3: Forecast operating performance

Calculating the long-term debt accelerated repayments

Each tranche of LT debt balance is

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forecast using a BASE analysis

Beginning
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Subtract mandated repayment

Subtract accelerated repayment
Ending
Cash available after
accelerated repayment
of previous layer

Accelerated LT debt
Lower of
repayment

Beginning debt balance

after mandated repayment

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Excess cash
Excess cash can accumulate once all debt repaid

Method Calculation

Once all debt is repaid, then excess The excess cash balance will
cash balances can start to accumulate automatically be calculated by the
cash flow statement

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Step 3: Forecast operating performance

Calculate interest expense and interest income
• Senior debt pays cash interest. Since
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these are amortizing loans (i.e. the

principal may be repaid in installments
AM

over the forecast period), interest is

calculated on the average balance
• Bullet repayment loans (e.g. high yield)
pay cash interest. Since there is no
repayment during our forecast period,
interest can be calculated on the
beginning balance
• PIK interest is paid in kind (rolled up on
the balance of the loan) and calculated
on the beginning balance

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Step 3: Forecast operating performance

Link up the debt balances to cash flow statement

• Once the cash sweep is completed

the debt balances based on the
forecast mandated and accelerated
repayments are known and can be
summarised
• The changes in the debt balances

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can now be linked up to the cash
flow statement

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Step 3: Forecast operating performance

Wire up interest: Cash flow statement and income statement
• Wiring up the interest into the income
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statement and cash flow statement

creates a circularity
AM

• At this stage, the iteration box in

Excel's settings must be switched on
• The interest calculations must be
linked into the income statement first,
using an IF statement that references
the circularity switch
• Lastly the interest from the income
statement can be linked into the cash
flow statement

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Debt analysis
Ratios
• Leverage and coverage ratios should
be calculated
• Debt ratios are used to analyze the
development of the financial structure
in time, and are also useful to compare
this transaction to other deals
• Debt ratios are used to establish

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covenants designed to protect the
lenders
• In some jurisdictions there are

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limitations on the deductibility of
interest (e.g. interest deductibility of no
more than 30% of EBITDA)
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Debt analysis
Average life

• The repayment amortizing debt is not ‘straight line’. The average life
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calculates the maturity of an equivalent ‘bullet’ loan

• Each repayment is multiplied by the year number and the sum of the
AM

weighted repayments is then divided by the original loan amount

• The = SUMPRODUCT (range of years,range of repayments) function
simplifies this calculation

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Debt analysis
Repayment year

• Term A amortizes over 7 years, term B must be repaid in year 8 and term C
in year 9
• If the debt is not repaid in full before its maturity, the firm is taking refinancing
risk
• The subordinated debt in this model has a 10-year maturity

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• The COUNTIF function will check if the debt is repaid timely

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Step 4: Sources and uses of funds at exit

Equity value calculation

• The enterprise value at the end of

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each forecast year can be

calculated by multiplying the
AM

assumption for the exit EV /

EBITDA multiple by the EBITDA
forecast
• The equity value is calculated at the
end of each forecast year using the
forecast EV and the bridge from EV
to equity value for that date

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Step 5: Calculate the returns to investors: IRR

• The institutions invested in 100% of the shareholder loans and in part of the common stock
• The internal rate of return of the investment depends on 1) the initial investment, and on 2)
the value of the investment at exit
• The calculation of the value of the investment at exit may need to reflect that the %
ownership of the institutional investors could be diluted by the mezzanine warrants

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Calculate the returns to investors: MOIC

• Money on money or multiple on invested capital (MOIC), is one of the most fundamental
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performance measurements for private fund investing.

• Sometimes called TVPI (total value to paid-in) or the investment multiple, MOIC is calculated
AM

by dividing the sum of a fund's realized and unrealized value by the total amount invested

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Step 5: Calculate the returns to investors: Drivers

Drivers of return
• Debt repayment
– Enterprise value stays constant, but equity value rises as debt is repaid
• Margin enhancement (cost cutting and efficiency improvements)
– Enterprise value increases, debt stays constant or maybe repaid and equity value rises
• Multiple expansion
– Entry and exit multiples are often assumed to be constant (no multiple expansion)

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Step 5: Calculate the returns to investors

Sensitivity analysis
• For a comprehensive analysis of the deal, the model outputs should be
T

sensitized against changes in the main inputs

• Key inputs to flex in an LBO model
AM

– Financing structure
– Operating scenario
– Exit date
– Exit multiple
– Offer price
• Key outputs
– IRR
– MOIC
– Debt metrics

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Step 5: Calculate the returns to investors

Sensitivity analysis
A master and clone cell structure allows data tables
to be located on a different sheet to the input cells.
These clone cells drive the data tables as well as the
rest of the model.

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Step 5: Calculate the returns to investors

Master and clone driven data tables
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AM

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Cell links
Step 5: Calculate the returns to investors Formulae links
Master and clone driven data tables set up Data table links
Assumptions sheet Sensitivity sheet Rest of model
Master Clone
Output driven by clones
WACC 8.0% WACC Link to master
Output
Growth 3.0% Growth Link to master

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WACC
Formula Master - 1 Master Master +1
Master – 1 Output Output Output

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Growth Master Output Output Output
Master + 1 Output Output Output

Output
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Cell links
Step 5: Calculate the returns to investors Formulae links
Master and clone set up for a one input, multi output data table Data table links
Scenarios sheet Sensitivity sheet Rest of model
T

Master Clone
Output driven by clones
Scenario 1 Scenario Link to master
AM

Output

Formula Formula Formula

1 Output Output Output
Scenario 2 Output Output Output
3 Output Output Output

Output

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LBO financing
The financing structure

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Setting up the financing structure

Sources and uses of funds

Sources Uses
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• Cash • Purchase of targets equity

AM

– Excess cash from target balance • Retire existing target debt

sheet • Transaction fees and expenses
• Debt • Cash to target balance sheet
• Equity – Working capital requirements

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Setting up the financing structure

• Financial sponsors aim to maximize the amount of debt used in the

acquisition, and minimize the equity
• This is achieved through:
– Creating debt products whose terms are tailored to the needs of debt investors
– Tapping into different segments of the credit market

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– Allocating debt within the corporate structure according to a ‘structural subordination’
logic
– Liquidity to operate the business
• Reach out to capital markets and internal credit teams for input on likely

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financing structure
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The term structure of LBO financing

• Extending the term (maturity) of the financing increases the debt capacity of
T

a business
– Borrow against cash flows further and further out in time
AM

• For the lender, extending the term increases risk

• The term profile of an LBO financing structure is built in order of seniority
– The more senior the debt, the earlier the cash flow claim, the shorter the debt maturity

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LBO financing
Sources of funds in detail; term structure
• Term Loans
Senior secured debt
Can be split into tranches (e.g. A, B, C), Maturity 7 years
• Second lien
Senior secured debt
Maturity 8 years Maturities are
illustrative
Senior unsecured • High yield bonds
debt Maturity 8 years

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• Mezzanine finance
Subordinated debt
Maturity 8 years
• Other subordinated debt

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Other debt
Maturity 8 years
• LBO sponsor, Existing shareholders, Management
Equity
Targeted return c. 20% IRR
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Debt instruments
General characteristics
• Amount borrowed and principal
T

• Cost: interest
– Cash interest vs PIK interest
AM

• Repayment date: maturity date

– Bullet repayment vs amortizing
• Security: collateral
– Secured vs unsecured
– 1st lien vs 2nd lien
• Priority of payment: seniority
– Senior vs junior; subordinated vs unsubordinated
• Covenants
• Op Co. vs. Hold Co.
• Other features (convertible, callable, cum-warrants etc)

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Common covenants
Credit ratios act as early warning system; Ratios monitored

Coverage ratios Leverage

• EBITDA / Interest expense • Senior debt / EBITDA

• (EBITDA – Capex) / Interest • Net debt / EBITDA
expense • Total debt / EBITDA
• FCF / Total debt

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Whilst these covenants are typically used,

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remember that EBITDA does not equal FCF

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Senior secured debt

Cost of senior debt

Typically split into tranches Cost of senior debt

T

Term Maturity Repayment Spread • Lowest cost debt because of lower

AM

A 6 yrs Amortizing 300 risk due to:

B 7 yrs Bullet 400
– Security
C 8 yrs Bullet 500
– Covenants
– Ranking
Indicative spread
over reference • Floating interest rate
rate
– Often partly swapped into fixed rate

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Senior secured debt

Second lien

• Helps to extend secured debt and therefore reduces the overall cost of
funding
• Floating interest rate, bullet repayment
• Secured via a second ranking fixed charge
– ‘Lien’ is a legal word that means a security charge like a mortgage

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– The lender only gets what is left over after the first ranking charge has been satisfied (the
revolving credit facility and term loans)
• Minor financing source

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• Investor base is primarily hedge funds

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Senior secured debt

Establishing the senior debt capacity of the target

Cash flow lending EBITDA multiple as a proxy

T

• The maximum debt capacity can be • EBITDA is often used as a quick-

AM

estimated using cash flow and-dirty benchmark for cash flow

projections and some financing – Debt financing is often quoted as a
assumptions multiple of EBITDA
• LTM EBITDA used as key reference
• Cash flow available for debt
point
servicing is calculated
• EBITDA measures earnings not
– The cash flow that can be used to cash flow
repay the principal plus the interest
– Check cash conversion ratio: FCF /
– Equal to the free cash flow (FCF) NOPAT

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Senior unsecured debt

High yield debt

Features Advantages / Disadvantages

• High yield debt sold • Advantages

– In the public markets via bonds; or – More flexible
– Can be placed via private – Less restrictive covenants
placement to specific bond (incurrence basis)

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investors (under rule 144A) – No amortization
• Typically minimum size of $100m / • Disadvantages
£100m / €100m – Higher cost

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– Usually cannot be called until after
3 – 5 years
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Subordinated debt
Mezzanine debt

Features Advantages / Disadvantages

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• Interest may be PIK • Advantages

AM

• Sometimes with warrants attached – Few covenants

• Return measured as an internal – Maximizes leverage
rate of return – PIK allows cash to be conserved
– a blend of the return on the loan • Disadvantages:
plus the value of the warrants – Significantly higher cost
– typically mid-teens, but will vary – Dilution of equity returns
through the cycle • Via warrants

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Equity
The equity contribution is split between two components

• 25% – 40% of total capital (1)

• Split is primarily driven by the need to incentivize management
– Preferred stock (or shareholder / vendor loan notes)
• Institutional investors
• Usually PIK dividends
– Common stock

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• Institutional investors and management
• Often pays no dividends (prevented by debt covenants)
• Target IRR for institutional investors c. 20% (1)

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(1) Market currently sees deals with equity up to 50% and target IRR at 15 to 20%

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Structural subordination
Debt push down

• Debt investors want to be as close

Parent company
T

as possible to the operational cash

flows • Sponsor equity
AM

• Prefer to lend to operating • Management equity

companies if possible Holding company
• If not possible will lend to holding
companies which receive dividends • Subordinated debt
from the operational business
• Equity investors will invest at the Operating company
parent company level • Senior unsecured debt
• Senior secured debt

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Please note:
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All materials are the intellectual property of AMT Training. Please visit us on: www.amttraining.com
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