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1. and
present
A Summary of
Leveraged Buyout
(LBO) Models

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Copyright 2009

3. About The Investment Banking Institute
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4. Table of Contents
I. Uses for An LBO Model
II. Components of LBO Model
III. IRR Analysis
IV. Q&A
Copyright 2009

5. Uses for an LBO Model
 An LBO Model is an analysis used by private equity
firms (financial sponsors) to evaluate an acquisition
 The goal of an LBO is to acquire a company by
financing the purchase with as much debt as cash flow
and debt markets will support
 The more debt available, the smaller an equity
investment the financial sponsor has to make
 The higher the leverage, the higher the expected IRR
for the financial sponsor or private equity firm
Copyright 2009

6. Uses for an LBO Model (cont’d)
 The goal of an LBO model is to establish expected
internal rates of return (“IRR”) for the acquisition
that reflects:
 Purchase price assumptions and the cash needed
 Capitalization assumptions: leverage, debt tranches, equity
investments
 Base case financial projections for balance sheet, cash flow
and income statement
 Model should include sensitivity functions for a
range of:
 purchase prices,
 capitalization structures,
 operating assumptions
Copyright 2009

7. Uses for an LBO Model (cont’d)
 Private Equity Firms / Financial Sponsors usually have
a required rate of return hurdle
 Expected transaction IRR must meet or exceed hurdle rate
 PE firms required rates of return usually range from 15% to
30% (18% - 25% typical)
 The IRR analysis is strongly driven by the amount of
leverage
 With higher leverage, less equity, and higher IRR
 Often the goal is to leverage up the Company based on cash
flow and the debt markets
 More leverage increases risk, as cash flows will pay interest
and debt service
Copyright 2009

8. Uses for an LBO Model (cont’d)
 Leverage is largely determined by the debt markets
 Until mid-2007, the debt markets were experiencing
excess liquidity
 Lenders were allowing higher leverage
 In 2005-2007 leveraged at 4.0–6.0x recent EBITDA
 Higher levels allowed higher prices yet still attain
the required IRR
Copyright 2009

9. Uses for an LBO Model (cont’d)
 Leverage is comprised of some combination
of:
 Senior secured loans
 Junior loans/bonds
 Mezzanine debt, or “hybrid” securities
 Lenders may require the financial sponsor to
have a minimum equity investment
 Minimum equity contribution is typically around
20% - 25% of total capitalization
Copyright 2009

10. Uses for an LBO Model (cont’d)
 Not Just for Buyers
 The LBO Model is also used by lenders
 Lenders like to see expected leverage and debt
service coverage ratios based upon Company’s
projected:
– income statement,
– balance sheet,
– cash flow
Copyright 2009

11. Pop Quiz
 The goal of an LBO model is to establish
expected internal rates of return (“IRR”)
using a financial model that reflects:
 a. Purchase price assumptions and uses of cash
 b. Capitalization assumptions and sources of cash
 c. Base case financial projections with
assumptions
 d. All the above.
Copyright 2009

12. Pop Quiz
 The goal of an LBO model is to establish
expected internal rates of return (“IRR”)
using a financial model that reflects:
 a. Purchase price assumptions and uses of cash
 b. Capitalization assumptions and sources of cash
 c. Base case financial projections with
assumptions
 d. All the above.
Copyright 2009

13. I. Uses for An LBO Model
II. Components of LBO Model
III. IRR Analysis
IV. Q&A
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14. Components of LBO Model
 Typical LBO Model will contain, at a minimum, the
following items:
 Purchase price assumptions
 Uses of Cash Schedule
 Sources of Cash Schedule
 Capital Structure Alternatives
 Pro Forma Balance Sheet
 Integrated Financial Model
 IRR Analyses
Copyright 2009

15. Purchase Price Calculation and Considerations
 Determination of the purchase price typically
involves a full-scale valuation of the company:
 Comparable Companies Analysis
 Precedent Transactions Analysis
 Discounted Cash Flow Analysis
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16. Sources and Uses of Cash
 Total Uses is the amount of cash necessary to
complete the transaction
 Total Sources is capital required to complete the
transaction
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17. Sources and Uses of Cash (cont’d)
 The Sources of Cash schedule is comprised of the capitalization
assumptions
 An example of a Sources and Uses of Cash Schedule (millions $):
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18. Capital Structure Alternatives
 Debt may be comprised of different securities
usually provided by different lenders
 Revolver / Term loan (senior secured loans)
– Usually provided by typical commercial banks
– Have lower interest rates
 Junior loans can be provided by public markets
(high yield issue) and private placements
 Often, the most junior piece on debt will have
equity warrants attached
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19. Capital Structure Alternatives (cont’d)
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20. Proforma Balance Sheet
 Proforma balance sheet gives effect for the transaction
 Adjusts the historical balance sheet for the new sources
of debt and equity as well as any transaction-related
adjustments:
 Write-ups or write-downs
 All financing fees incurred can be capitalized and amortized
 Any Goodwill created by the transaction
 The buyer typically assumes all of the normal-course
short term liabilities
 The “old debt” is typically eliminated
Copyright 2009

21. Proforma Balance Sheet (cont’d)
 Proforma Balance Sheet example (assets):
Proforma Balance Sheet
($ in millions)
Historical Financing/ Proforma
Balance Sheet Dec. 31 Transaction Dec. 31
Assets 2008 Adjustments 2008
Cash $0.0 $0.0 $0.0
Accounts Receivable $16.0 0.0 16.0
Inventory $10.0 0.0 10.0
Other Current Assets $1.0 0.0 1.0
Total Current Assets $27.0 $0.0 $27.0
Gross PP&E $323.2 $0.0 $323.2
Cumulative Depreciation $45.0 0.0 45.0
Net PP&E $278.2 $0.0 $278.2
Amortizable Intangibles $0.0 $8.0 $8.0
Goodwill 5.0 65.2 70.2
Total Assets $310.2 $73.2 $383.4
Copyright 2009

22. Proforma Balance Sheet (cont’d)
 Liabilities Balance Sheet
Historical
Dec. 31
Financing/
Transaction
Proforma
Dec. 31
& Equity Liabilities 2008 Adjustments 2008
Accounts Payable $11.0 $0.0 $11.0
Accrued Liabilities $2.4 0.0 $2.4
Other Current Liabilities $0.0 0.0 0.0
Total Current Liabilities $13.4 $0.0 $13.4
Existing Debt
Revolving Credit Facility $40.8 ($40.8) $0.0
Term Loan $100.0 ($100.0) $0.0
Unsecured Debt $50.0 ($50.0) $0.0
New Debt
Revolving Credit Facility $0.0 $0.0 $0.0
Term Loan 0.0 $120.0 $120.0
Senior Bonds 0.0 $90.0 $90.0
Unsecured Debt 0.0 $60.0 $60.0
Other Liabilities $2.0 $0.0 $2.0
Total Liabilities $206.2 $79.2 $285.4
Shareholders Equity
Retained Earnings $94.0 ($100.0) ($6.0)
Common Stock 10.0 $94.0 104.0
Total Shareholders Equity $104.0 ($6.0) $98.0
Total Liabilities and Equity $310.2 $73.2 $383.4
Copyright 2009

23. Financial Statement Projections
 An LBO model must also include forecasted income
statement, balance sheet, cash flow and debt
schedule
 This allows us to forecast performance of the
company on a post-LBO basis to see:
 How well the company is able to service the increased debt;
 How profitable the company can be following the LBO; and
 How the company might be valued at the end of the
anticipated holding period
Copyright 2009

24. Pop Quiz
 Which of the following is not included in total
uses of cash?
 a. purchase price
 b. transaction fees
 c. debt service
 d. other required cash payments in the transaction
 e. none
Copyright 2009

25. Pop Quiz
 Which of the following is not included in total
uses of cash?
 a. purchase price
 b. transaction fees
 c. debt service
 d. other required cash payments in the transaction
 e. none
Copyright 2009

26. I. Uses for An LBO Model
II. Components of LBO Model
III. IRR Analysis
IV. Q&A
Copyright 2009

27. IRR Analysis
 The IRR analysis accounts for:
 Cash flows from the financial sponsor into the
company
 Cash flows to the financial sponsor during the
holding period
 Net proceeds to the sponsor following the sale of
the company (aka “exit”)
Copyright 2009

28. IRR Analysis (cont’d)
 Example of exit value calculation:
SALE OF COMPANY A IN 2013
Closing Date 31-Dec-13
2012 EBITDA $76.6
EBITDA Multiple 6.0x
Transaction Value $459.5
Less: Total Debt (190.5)
Plus: Cash Balance 0.0
Less: Transaction Fees (1) (6.6)
Equity Value $262.4
% Equity to Sponsor 95.0%
Equity to Sponsor $249.3
% Equity to Unsecured Lender 5.0%
Equity to Unsecured Lender $13.1
(1) Assumes 1% of Purchase Price for Investment Banking Fees, plus $2 million in legal and other expenses.
Copyright 2009

29. IRR Analysis for Financial Sponsors
 Example of IRR analysis for financial sponsor:
IRR to Financial Sponsor 12/31/08 12/31/09 12/31/10 12/31/11 12/31/12 12/31/13
Initial Equity Investment ($104.0) $0.0 $0.0 $0.0 $0.0 $0.0
Dividends 0.0 0.0 0.0 0.0 0.0 0.0
Proceeds at Sale 0.0 0.0 0.0 0.0 0.0 249.3
Total Cash Flows to Sponsor ($104.0) $0.0 $0.0 $0.0 $0.0 $249.3
IRR Calculation 19.1%
Copyright 2009

30. Pop Quiz
 The IRR analysis accounts for:
 a. Cash flows from the financial sponsor into
the company
 b. Cash flows to the financial sponsor during
the holding period
 c. Net proceeds to the sponsor following the
sale of the company
 d. All of the above
Copyright 2009

31. Pop Quiz
 The IRR analysis accounts for:
 a. Cash flows from the financial sponsor into
the company
 b. Cash flows to the financial sponsor during
the holding period
 c. Net proceeds to the sponsor following the
sale of the company
 d. All of the above
Copyright 2009

32. I. Uses for An LBO Model
II. Construction of LBO Model
III. IRR Analysis
IV. Q&A
Copyright 2009

33. Q&A
Q: When is the LBO considered an
appropriate method over other
financing options?
Copyright 2009

34. Q&A
Q: How have current market
conditions affected the LBO
model?
Copyright 2009

35. Q&A
Q: Common pitfalls and how to avoid?
Copyright 2009

36. Q&A
Q: Best tools and resources for LBO
modeling?
Copyright 2009

37. Q&A
Q: Is there a difference modeling an
LBO for a private company vs.
public company?
Copyright 2009

38. and
Thank You.

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I am so thankful for the class I took at the Investment Banking Institute. It was both
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Your walkthrough of the DCF calculations was an excellent refresher. While I still
remember bits and pieces of how DCF works from my on-campus interviews back in
college and work at JP Morgan, your presentation helped to consolidate everything
in my mind. I also appreciate how you tied things back to an estimate of the
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