Monthly Archives: June 2023

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### What’s the purpose of creating a 3-statement model for an LBO?

Creating a 3-statement model enhances the accuracy of the model. If the balance sheet balances, that is very useful proof that the model is working. Furthermore, lenders and investors may wish to see the value of the assets and liabilities, as well as changes in the balance sheet over time. Lenders ...

### If you buy a company at 10x EV / EBITDA with 5x debt / EBITDA and sell it at 10x EV / EBITDA 5 years later, what is the IRR if the EBITDA has doubled? Assume no debt has been paid down.

If we hypothetically say that LTM EBITDA is \$1M, then we buy the company at an enterprise value 10 x \$1M = \$10M. We borrow 5 x \$1M = \$5M, so we have to put in \$10M – \$5M = \$5M of equity. After 5 years, if EBITDA doubled, then ending EBITDA is \$2M. If […]...

### What are some error checks you could do to make sure your LBO model is correct?

You can make sure your balance sheet balances: total assets = total liabilities + shareholder’s equity. You can also try to build a bridge from EBITDA. You can also look at the cash flow statement as well to make sure debt repayments / borrowings are linked properly to the debt schedule. If you ar...

### What is the simplest LBO model you could make?

A simplified LBO model would not include a balance sheet or a full cash flow statement, although we still need the income statement and several key items from the cash flow statement. We would calculate levered free cash flow (LFCF) using the following formula: LFCF = Net Income + D&A – ca...

### Why do PE firms use an LBO model instead of a DCF model?

PE firms need to forecast their cash flows available for financing, which shows how much debt they need to borrow or repay. This way, they can build a debt schedule and figure out how much debt they can pay back, which allows them to find their ending equity after selling their company. By comparing...

### When do private equity firms hire investment banks?

PE firms usually use investment banks when they sell one of their portfolio companies. This is because selling a company requires an extensive network of buyers which investment banks have access to. Additionally, there are also a lot of processes that investment banks have automated, and they are a...

### What are the key factors you have to consider when deciding your exit strategy?

We need to consider the type of exit strategy, the type of buyers, and the sector outlook. Type of exit strategy: we could do an IPO, sell to a strategic acquiror, or sell to a private equity company Type of buyers: Will the buyers be strategic, financial sponsors, or both? Which sectors are they in...

### How do you calculate the cash available for debt repayment?

In order to calculate the cash available for debt repayment, we will need to find cash flow before financing items (CFO + CFI), and then deduct any mandatory amortization (mandatory debt repayments). We also need to account for any cash we have on the balance sheet and our minimum cash balance. Cash...

### What is a liquidation preference and preferred return in a PE deal?

The sponsor who sourced the deal and performed the initial due diligence is sometimes rewarded with a liquidation preference and a preferred return. This guarantees that, upon the sale of the company, the sponsor will receive their initial investment back before other co-investors receive any procee...

### What type of debt has PIK interest?

PIK interest is a non-cash interest expense, and PIK stands for payment-in-kind. Instead of deducting cash, we simply increase the debt by the amount of the interest expense. It’s like a credit card balance with a growing debt balance when interest expense is not paid. Typically, we see PIK intere...