Definition
A Pro Forma Balance Sheet is a post-transaction balance sheet that reflects the target company’s financial position after the completion of an acquisition, such as a Leveraged Buyout (LBO). It incorporates changes to the balance sheet resulting from the transaction, including the new Capital Structure, the recognition of Goodwill, and the impact of Transaction Assumptions and Transaction Costs.
Purpose and Importance
- It illustrates the company’s financial structure immediately following the acquisition.
- It is a crucial step in Leveraged Buyout modeling.
- It incorporates the funding of the acquisition as outlined in the Sources and Uses schedule.
- It reflects the new debt financing based on the Debt Assumptions, including the amounts of different Debt Instruments.
- It accounts for the goodwill created as the excess of the purchase price over the fair value of Net Assets acquired. The purchase price is often derived from the Entry Valuation and reconciled to equity value through the Enterprise Value to Equity Value Bridge.
- It shows the impact of Transaction Costs, including how financing fees are capitalized and other costs are expensed.
- It forms the basis for future financial projections and analysis, including the assessment of leverage and coverage ratios.
Key Elements and Linkages
Assets: - Existing Assets: The target company’s pre-transaction assets, potentially adjusted to fair value. - Goodwill: Calculated based on the purchase price and the fair value of Net Identifiable Assets Valuation. - Capitalized Financing Fees: Upfront fees related to arranging debt, which are capitalized and amortized over the loan term. - Cash: Reflects the cash balance at closing, potentially including any excess cash contributed as per Transaction Assumptions. Liabilities: - New Debt: The amounts of the various Debt Instruments raised to finance the acquisition, as per the Debt Assumptions. This debt structure directly impacts future interest expense and mandatory repayment capacity. - Existing Debt (if not refinanced): Any existing debt that remains on the balance sheet post-transaction. If existing debt is repaid at close, it is accounted for in the Sources and Uses schedule. - Deferred Tax Liability: May arise due to the Write-up of Assets to fair value, calculated based on the tax rate. Equity: - Reflects the equity contribution from the financial sponsor and any rolled equity from existing shareholders or management. The initial equity value can be derived from the Enterprise Value using the Enterprise Value to Equity Value Bridge, considering Net Debt and other adjustments. Retained earnings are adjusted for expensed Transaction Costs.
The Pro Forma Balance Sheet is a critical output of the LBO model, providing a snapshot of the post-acquisition financial position and serving as a starting point for analyzing the viability and potential returns of the transaction.