Definition
A leveraged buyout refers to the acquisition of a Target Company in which a large portion of the purchase price is financed with debt. The financial sponsor typically secures the financing before the transaction closes and contributes the remaining capital from their own funds.
LBOs are typically pursued to enhance investment returns through financial leverage, often in the context of private equity transactions targeting undervalued or underperforming businesses with potential for operational improvement.
Suitable targets typically have stable and predictable cash flows, strong asset bases, and a capacity for value creation through operational or strategic change.
Modeling
The term can also refer to the financial model, typically built in Excel, used to forecast investor returns in such a transaction.
- Entry Valuation: Determining the value of the asset
- Enterprise Value To Equity Value Bridge: Since valuations often reflect the entire enterprise, adjustments are required to derive the price paid for the seller’s equity.
- Transaction Assumptions: Assumptions must be made regarding transaction costs and funding requirements.
- Debt Assumptions: Key questions include the size of the financing package and its terms.
- Goodwill Calculation: This step calculates the goodwill created as the excess of the purchase price over the fair value of Net Assets acquired.
- Pro Forma Balance Sheet: This step reflects the target’s balance sheet post-transaction, incorporating the new capital structure.
- Sources and Uses: Outlines how the total transaction cost is allocated (uses) and how it is financed (sources).
- Operating Model: Typically includes the Income Statement, Cash Flow Statement, and supporting schedules such as the debt schedule, revenue build-up, and tax schedule. The Balance Sheet is often simplified to focus on key metrics such as net debt and working capital.
- Returns Calculation: Calculates the investor’s returns based on the model’s assumptions.
- Sensitivity Analysis: Returns are tested for sensitivity to key assumptions, acknowledging that actual outcomes will differ from projections.