How and Why a Leveraged Buyout (LBO) Works ?

Take a look at this example below of a 100% cash purchase of a house vs. a 20% cash purchase to see how the math works:

House Value: Debt Interest Rate:

Sale Value: Debt Principal Repayment:
Annual Rental Income:

Scenario 1 - 0.0% Cash Purchase:

Cash Used:
Debt Used:

Revenue and Expenses: Purchase Year 1 Year 2 Year 3 Year 4 Year 5

Rental Income:
Interest Payments:
Debt Principal Payments:
Repay Remaining Debt Upon Exit:
Purchase or Sale of Property:
Net Cash Flow:

Money-on-Money (MoM) Multiple:

Internal Rate of Return (IRR):

Scenario 2 - 0.0% Cash Purchase:

Cash Used:
Debt Used / Remaining:

Revenue and Expenses: Purchase Year 1 Year 2 Year 3 Year 4 Year 5

Rental Income:
Interest Payments:
Debt Principal Payments:
Repay Remaining Debt Upon Exit:
Purchase or Sale of Property:
Net Cash Flow:

Money-on-Money (MoM) Multiple:

Internal Rate of Return (IRR):
 Simple LBO Model Example - Private Company

Transaction Assumptions: Units: Units:

EBITDA Purchase Multiple: x 12.0 x EBITDA Exit Multiple: x 12.0 x

Purchase Enterprise Value: $M Minimum Cash % EBITDA: % 20.0%

(+) Cash: $M 50 Tax Rate: % 25.0%
(-) Debt: $M (100)
Purchase Equity Value: $M Advisory Fee %: % 1.0%
Debt Issuance Fee %: % 2.0%
Leverage Ratio: x 5.0 x
Debt Used: $M Legal and Other Fees: $M $ 2
Interest Rate: % 5.0%

Sources & Uses for a Cash-Free, Debt-Free Deal:

Sources: Uses:
New Debt Issued: Purchase Enterprise Value of Target:
Investor Equity: Transaction Fees:
#DIV/0! Total Sources: Financing Fees:
Minimum Cash
Total Uses:

CHECK: OK!

Income Statement: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Revenue: $ 250
Growth Rate: 10% 8% 6% 5% 5%

EBITDA:
Margin: 20% 21% 22% 23% 24% 25%
Growth Rate:

(-) Depreciation & Amortization:

% of Revenue: (10%) (9%) (8%) (7%) (6%)

(-) Interest Expense:

Pre-Tax Income:
(-) Taxes:
Net Income:

Cash Flow and Debt Repayment: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net Income:

(+) Depreciation & Amortization:

(+/-) Change in Working Capital:
% of Change in Revenue: (10%) (5%) 0% 3% 5%

(-) CapEx:
% of Change in Revenue: (20%) (19%) (18%) (17%) (16%)

(+) Beginning Cash Balance:

(+) Free Cash Flow:
(-) Minimum Cash Balance:
Cash Flow Available for Debt Repayment:

Cash Flow Used for Debt Repayment:

Debt Balance:
Cash Balance:
Equity Balance:

Invested Capital:
NOPAT:
Return on Invested Capital (ROIC):

Returns Attribution Analysis: Amount: %: Exit Calculations:

EBITDA Growth: Exit Enterprise Value:
Multiple Expansion: (-) Debt:
Debt Paydown/Cash Generation: - (+) Cash:
Total Return to Equity Investors: Equity Proceeds:

Money-on-Money (MoM) Multiple:

Internal Rate of Return (IRR):
Simple LBO Model Example - Public Company

Transaction Assumptions: Units: 0

Current Share Price: $ as Stated $ 8.00 EBITDA Exit Multiple: x 12.0 x

Diluted Share Count: M Shares 55.0
Minimum Cash % EBITDA: % 20.0%
Premium Paid: % 25.0% Tax Rate: % 25.0%

Purchase Equity Value: $M Advisory Fee %: % 1.0%

(-) Cash: $M (50) Debt Issuance Fee %: % 2.0%
(+) Debt: $M 100
Purchase Enterprise Value: $M Legal and Other Fees: $M $ 2

EBITDA Purchase Multiple: x #DIV/0!

Leverage Ratio: x 5.0 x

Total Debt Used: $M
Interest Rate: % 5.0%

Sources & Uses:

Sources: Uses:
New Debt Issued: Equity Purchase Price of Target:
Assume/Replace Target's Debt: Assume/Replace Target's Debt:
Excess Cash on Balance Sheet: Transaction Fees:
Investor Equity: Financing Fees:
Total Sources: Total Uses:

CHECK: OK!

Income Statement: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Revenue: $ 250
Growth Rate: 10% 8% 6% 5% 5%

EBITDA:
Margin: 20% 21% 22% 23% 24% 25%
Growth Rate:

(-) Depreciation & Amortization:

% of Revenue: (10%) (9%) (8%) (7%) (6%)

(-) Interest Expense:

Pre-Tax Income:
(-) Taxes:
Net Income:

Cash Flow and Debt Repayment: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net Income:

(+) Depreciation & Amortization:

(+/-) Change in Working Capital:
% of Change in Revenue: (10%) (5%) 0% 3% 5%

(-) CapEx:
% of Change in Revenue: (20%) (19%) (18%) (17%) (16%)

(+) Beginning Cash Balance:

(+) Free Cash Flow:
(-) Minimum Cash Balance:
Cash Flow Available for Debt Repayment:

Cash Flow Used for Debt Repayment:

Debt Balance:
Cash Balance:
Equity Balance:

Invested Capital:
NOPAT:
Return on Invested Capital (ROIC):

Returns Attribution Analysis: Amount: %: Exit Calculations:

EBITDA Growth: Exit Enterprise Value:
Multiple Expansion: (-) Debt:
Debt Paydown/Cash Generation: (+) Cash:
Total Return to Equity Investors: Equity Proceeds:

Money-on-Money (MoM) Multiple:

Internal Rate of Return (IRR):
Leveraged Buyout (LBO) Model Exit Strategies - M&A vs. IPO vs. Dividends / Recapitalizations
(USD $ in Millions Except Per Share and Per Unit Data)

"Standard Exit" - M&A Deal Scenario Where Another Normal Company or Private Equity Firm Acquires the Company in Year 5 of the Buyout Period:

Returns Calculations: Units Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

EBITDA Exit Multiple: x 12.0 x

EBITDA: $M $ 50 87

Exit Enterprise Value: $M $ 1,041

(-) Net Debt: $M -
Equity Value on Exit: $M $ 1,041

Returns to Investors:
Sponsor Common Equity:
Initial Investment: $M $ (373)
Dividends: $M - - - - -
Investor Equity: $M 1,041
Total Cash Flows: $M $ (373) $ - $ - $ - $ - $ 1,041

Money-on-Money (MoM) Mult x 2.8 x

Internal Rate of Return (IRR): % 23%

IPO Exit - PE Firm Takes the Company Public, and Then Sells Off Its Holdings Over 4 Years (20% in Year 1, 35% in Year 2, 30% in Year 3, and 15% in Year 4):

Returns Calculations: Units Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

EBITDA Exit Multiple: x 12.0 x

EBITDA: $M $ 50 87

Exit Enterprise Value: $M $ 1,041

(-) Net Debt: $M -
Equity Value on Exit: $M $ 1,041

Share Price Increase Over IPO % 0% 10% 20% 30%

% Stake Sold by PE Firm: % 20% 35% 30% 15%

Returns to Investors:
Sponsor Common Equity:
Initial Investment: $M $ (373)
Dividends: $M - - - - - - - -
Investor Equity: $M 208 401 375 203
Total Cash Flows: $M $ (373) $ - $ - $ - $ - $ 208 $ 401 $ 375 $ 203

Money-on-Money (MoM) Mult x 3.2 x We're assuming here that the share price increases by 10% in Year 2, 20% in Year 3,
Internal Rate of Return (IRR): % 20% and 30% in Year 4… but that doesn't necessarily happen in real life. It could also drop!

Dividend / Recapitalization Scenario Where the PE Firm Holds the Company Indefinitely, and the Company Simply Issues Dividends to the PE Firm Over Time:

Returns Calculations: Units Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

EBITDA Exit Multiple: x 12.0 x

EBITDA: $M $ 50 87

Exit Enterprise Value: $M $ 1,041.3

(-) Net Debt: $M -
Equity Value on Exit: $M
Investor Equity: $M

Returns to Investors:
Sponsor Common Equity:
Initial Investment: $M $ (373)
Dividends: $M 30 40 50 60 70 80 90 100 110 120
Investor Equity: $M
Total Cash Flows: $M $ (373) $ 30 $ 40 $ 50 $ 60 $ 70 $ 80 $ 90 $ 100 $ 110 $ 120

Money-on-Money (MoM) Mult x 2.0 x

Internal Rate of Return (IRR): % 12%