LBO MODEL - ADVANCED EXAM QUESTIONS AND
ANSWERS WITH COMPLETE SOLUTIONS VERIFIED
LATEST UPDATE
Tell me about all the different kinds of debt you could use in an LBO and the
differences between everything.
See figure on p155
How would an asset write-up or write-down affect an LBO model? / Walk me
through how you adjust the Balance Sheet in an LBO model.
All of this is very similar to what you would see in a merger model - you calculate
Goodwill, Other Intangibles, and the rest of the write-ups in the same way, and then the
Balance Sheet adjustments (e.g. subtracting cash, adding in capitalized financing fees,
writing up assets, wiping out goodwill, adjusting the deferred tax assets / liabilities,
adding in new debt, etc.) are almost the same.
The key differences:
• In an LBO model you assume that the existing Shareholders' Equity is wiped out and
replaced by the equity the private equity firm contributes to buy the company; you may
also add in Preferred Stock, Management Rollover, or Rollover from Option Holders to
this number as well depending on what you're assuming for transaction financing.
• In an LBO model you'll usually be adding a lot more tranches of debt vs. what you
, would see in a merger model.
• In an LBO model you're not combining two companies' Balance Sheets.
Normally we care about the IRR for the equity investors in an LBO - the PE firm
that buys the company - but how do we calculate the IRR for the debt investors?
For the debt investors, you need to calculate the interest and principal payments they
receive from the company each year.
Then you simply use the IRR function in Excel and start with the negative amount of the
original debt for "Year 0," assume that the interest and principal payments each year
are your "cash flows" and then assume that the remaining debt balance in the final year
is your "exit value."
Most of the time, returns for debt investors will be lower than returns for the equity
investors - but if the deal goes poorly or the PE firm can't sell the company for a good
price, the reverse could easily be true.
Why might a private equity firm allot some of a company's new equity in an LBO
to a management option pool, and how would this affect the model?
This is done for the same reason you have an Earnout in an M&A deal: the PE firm
wants to incentivize the management team and keep everyone on-board until they exit
the investment.
The difference is that there's no technical limit on how much management might receive
from such an option pool: if they hit it out of the park, maybe they'll all become
ANSWERS WITH COMPLETE SOLUTIONS VERIFIED
LATEST UPDATE
Tell me about all the different kinds of debt you could use in an LBO and the
differences between everything.
See figure on p155
How would an asset write-up or write-down affect an LBO model? / Walk me
through how you adjust the Balance Sheet in an LBO model.
All of this is very similar to what you would see in a merger model - you calculate
Goodwill, Other Intangibles, and the rest of the write-ups in the same way, and then the
Balance Sheet adjustments (e.g. subtracting cash, adding in capitalized financing fees,
writing up assets, wiping out goodwill, adjusting the deferred tax assets / liabilities,
adding in new debt, etc.) are almost the same.
The key differences:
• In an LBO model you assume that the existing Shareholders' Equity is wiped out and
replaced by the equity the private equity firm contributes to buy the company; you may
also add in Preferred Stock, Management Rollover, or Rollover from Option Holders to
this number as well depending on what you're assuming for transaction financing.
• In an LBO model you'll usually be adding a lot more tranches of debt vs. what you
, would see in a merger model.
• In an LBO model you're not combining two companies' Balance Sheets.
Normally we care about the IRR for the equity investors in an LBO - the PE firm
that buys the company - but how do we calculate the IRR for the debt investors?
For the debt investors, you need to calculate the interest and principal payments they
receive from the company each year.
Then you simply use the IRR function in Excel and start with the negative amount of the
original debt for "Year 0," assume that the interest and principal payments each year
are your "cash flows" and then assume that the remaining debt balance in the final year
is your "exit value."
Most of the time, returns for debt investors will be lower than returns for the equity
investors - but if the deal goes poorly or the PE firm can't sell the company for a good
price, the reverse could easily be true.
Why might a private equity firm allot some of a company's new equity in an LBO
to a management option pool, and how would this affect the model?
This is done for the same reason you have an Earnout in an M&A deal: the PE firm
wants to incentivize the management team and keep everyone on-board until they exit
the investment.
The difference is that there's no technical limit on how much management might receive
from such an option pool: if they hit it out of the park, maybe they'll all become
