Buy Outs

What is a BuyOut
• Depending on how you look at it:
– Form of exit for an entrepreneur
– Form of entry by a team onto a company they
have been in or that they want to get in, not just
as mngt but as owners
– Investment opportunity to a VC

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 Key Features of a Buyout
• Good business with good cashflows / cashflow
potential
• Internal or external management that have
spotted an opportunity
• Use of debt
• VC Money or an investor with equity
• Ability to create value
• Opportunity to exit
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 Why Buyouts?
• Form of exit for entrepreneur - Entrepreneur
looking for an exit, or a big business looking to
sell a non-core business
• Form of entrepreneurship by management -
Motivated team, with a good strategy and a
good exit plan

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 Example
• AB Co. EBITDA = $9m, no third-party debt
• Comparable transactions at 10x EBITDA, so …
enterprise value = $ 90m
• Transaction fees (est.) = $4m
• Bank agrees to lend 4.5x EBITDA =
Management can afford to invest $300k
• VC agrees that management should own 10%

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 Financing for AB Co. MBO
Uses: Sources:
Paid to seller $90.0m Bank loan $40.0m
Trans. Fees $ 4.0m Mgt. Inv. $ 0.3m
Repay debt $ 0.0m VC Investment $53.7m
$94.0m $94.0m

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 Resulting Capital Structure
Inv. Prefs.* Ords. %
Management $ .3m $ 0 $ .3m 10%
VC $53.7m $51m $2.7m 90%
$3.0m 100%
* 10% dividend

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 Value Creation
Year 0 Year 5
AB Co. EBITDA $ 9m $ 15m
Exit multiple 10x 10x
Enterprise value $90m $150m
Repay bank debt -40m -25m
Equity Value $50m $125m

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 Equity Value
Year 5
Equity value $125m
Repay pref. shares + div.
(51m + 25m) $ 76m
Value of ord. shares $ 49m

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 Allocation of Equity Value

Value of ord. shares $49m

Management gets 10% $4.9m

VC gets 90% $44.1m

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 Returns

Management: Invested $ 0.3m

Returned $ 4.9m
VC: Invested $ 53.7m
Returned $120.0m
(51 + 25 + 44)

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 To Improve Returns
• More third party debt
• Faster growth of EBITDA
• Increase in Multiple

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The 7 Key Steps in a Buy Out 2

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Determine price – Enterprise
Value you want to pay

Step 1

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Determine total cash to fund the
deal:
• Cash to seller
• Repay existing debt (if any)
• Working Capital
• Transaction fees
• debt etc
Step 2

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Identify sources of cash for
deal:
•How much debt can company support?
What types & amounts of debt are
available? (Long-term bank debt, Mezzanine
debt, Vendor loan note)
Make sure company can service debt &
meet covenants!
Consider tranching debt with different
payment schedules
Step 3

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 Other Sources of cash:
 Equity
 Factoring
 Sale & leaseback
 Bridge loan for asset value
 Excess cash in the company

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Determine how much equity is needed & who
will provide it:
 Management team
 Venture capitalist

* Make sure total sources = total needs!

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 Determine projected exit value
for company:
Requires business forecasts that you
believe
Use same multiple as you are paying now

Step 4

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Calculate Management, VC IRR –
is there enough for everyone?

Step 5

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 Management:
Calculate VC’s required return (based on IRR
hurdle) & ownership

VC’s ownership = VC’s return amount /

company exit value

* Does that leave enough for management?

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 VC:
Start with % management should own
Take resulting VC ownership & calculate
return IRR for VC

* Is that return sufficient for VC?

* Is the resulting “envy ratio” acceptable?

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 Envy Ratio (ER)
• ER = (investment by investors / % of equity) /
(investment by management / % of equity)
• The ratio demonstrates how generous institutional
investors are to a management team—the higher the
ratio is, the better is the deal for management.
• As a rule of thumb, management should be expected to
invest anywhere from six months to one year’s gross
salary to demonstrate commitment and have some
"skin in the game".
• It is affected by how keen the investors are to do the
deal; the competition they are facing; and economic
factors
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Determine capital structure

Step 6

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 Determine capital structure
• Investment in ordinary shares:
 VC’s amount is a function of amount management
invests
• Instrument for balance of VC’s money:
 Redeeemable preference shares (loan stock?)
 Redemption date?
 Conversion/ participation details?

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 Re-work model:
•Raise VC projected return and / or
•Improve management ownership

3 levers:
•Reduce price
•Increase debt
•Change ownership percentages

Step 7

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Remember:
– Buyout models are very complex .
– The steps above are not sequential.
– The modeling process is iterative.
– The iterations involve a lot of judgment.

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What makes a proposition Bankable? 3

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 Bankable proposition
• Motivated / competent team
• Clear value addition process or steps
• Company that can support interest rates and
debt repayments
• Availability of debt / mez at good terms
• Clear opportunity for exit

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 Fact:
• Most business owners spend more time with
their banker than with VCs.
• Knowing what banks expect is key.

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 Keep in mind:
• Banks like to feel “safe”.
• They do not like risk – that’s what venture
capital is for!

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 Bankers feel safe with:
• A credible borrower
• Acceptable use of funds
• Credible business plan
• Complete financial package
• Believe repayment plan
• Acceptable security

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Of Debt and its advantage…

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