Welcome to the Wall Street Prep Quick Lesson Series!
In this lesson, we’ll build a leveraged buyout (LBO) model, given some operating and valuation assumptions, in Excel. The goal of this lesson is to show you that an LBO model is actually a very simple transaction at its core, and is quite similar to the mechanics involved when purchasing a home.
Instructor’s Note: In the comments section, in front of row #48 (LBO debt, beginning of period), the note is written as “LTM Debt * LBO Debt Capacity.” It should instead be labeled as “LTM EBITDA * LBO Debt Capacity.”
Before You Watch: Before diving in to the videos below, please read through this LBO Quick Lesson Primer, and be sure to download this lesson’s Excel model template: LBO Excel model template.
Building a Simple LBO Model – Video 1 of 3
Building a Simple LBO Model – Video 2 of 3
Building a Simple LBO Model – Video 3 of 3
Comments
Thank you for the amazing introduction to LBO. The analogy to buying a house does make the concept much easier to understand. Good job for explaining.
If I am not mistaking, you did not take into account the $600M of existing debt when inputting for the debt remaining balance in cell D42 for the second video at minute 5:09. Shouldn’t cell D42 be : D51+C42? Meaning the end of year new debt balance of $12,822M +… Read more »
Gabriel:
The $600MM in existing debt would be refinanced when this company is acquired.
Best,
Jeff
Hi Jeff, May I ask why we write off the $600mm old debt but keep the $100mm old cash? I thought it was already paid to write off that 600mm debt, thats why our net debt is 500, thank you very much!
Stella:
The debt will usually be refinanced/paid back upon a change-of-control. However, the acquirer gets to keep the target company’s cash.
Best,
Jeff
Hi Jeff, Thank you so much for your reply. In this case, to calculate cell J60, (the highest purchase price the sponsors would be willing to pay for XYZ shares today), shall we calculate it as =(J59-C42)/C7 instead of =(J59-C43)/C7 ? Cus here we keep the target’s old cash, so… Read more »
Stella:
No, you still deduct net debt. Equity value is enterprise value less net debt. The acquirer effectively paid for the $100 in cash as part of the acquisition.
Best,
Jeff
Hi Jeff, Thank you very much for sharing the model. Very insightful and very useful! Can you please help me understand a couple of things? 1) What are the mechanics of an LBO as far as the legal structure is concerned? If I understand correctly, an LBO is a two-step transaction:… Read more »
Hi, Valerie, I’ll answer #2 first. By refinanced, we mean paid off (sorry for the confusion in terminology), which is typical for existing debt for an LBO target. As for #1, there are probably variants in how this can be legally done, but in the end, the PE fund is… Read more »
Hi, Jeff
Unfortunately, the structure I described cannot work. The newly formed entity will become a shareholder in the LBO target. And a company cannot merge with its subsidiary.
When answering question 2 of the second group of questions “What is the highest purchase price the sponsors would be willing to pay for XYZ shares today?”, why do we subtract Net Debt again? I mean we are using J59 which is equal to D48 + J56, where D48 was… Read more »
Jim:
The sponsor can raise equity and lever the company up to 6x. So this results in total proceeds of 20,480. The company has to pay off existing net debt (500) and then whatever is left over (19,980) can be used to purchase the existing equity.
Best,
Jeff
Ok thank you
Many thanks for simplifying this concept for us
You’re welcome!
Hi thank you for the videos. I have a question regarding video 2. Why did your “optional paydown” figures change when putting in the values for your cash, debt, and net debt values ?
Hi, Alex,
Our optional paydown depends on how much cash is available at the beginning of the year, so when that amount is copied to the right, it updates cash available for all later years and impacts the optional paydown.
BB
Thank you for this! I have a question regarding the table of Sources & Uses: In the uses should we add a cash injection of $50m in addition to the EPP and refinanced debt (600 here according to your assumption to not account for $100m cash in the target BS)… Read more »
Hi, Jami,
Yes, if the company needs to keep $50m of cash to operate, we would either have to keep $50m of the $100m or inject $50m if we used the $100m to offset the debt we refinanced.
BB
Thank for well explained LBO, use case made us to understand concept easily.
You’re welcome, Shivam!
Can I get more lectures on Advanced Financial Accounting along with IFRS????
HI, Muhammad,
Please check out our advanced accounting course: https://www.wallstreetprep.com/wsp_course/advanced-accounting/
BB
Given you use “Free cash flow after required debt paydown” and you keep it stable @8%… it seems you are missing out any operational leverage effect on the FCF, right?
Hi, Kevin,
Yes, in this very simple LBO model, by using a constant FCF margin, we are assuming that we are not benefitting from operating leverage, which would tend to increase the FCF margin if revenues continue to grow (and if gross profit margin holds steady). Great question!
BB
This is very well done. Simple framework/concept and helpful excel format. Doing it myself really helps to bridge knowing to understanding fully. What are some of the bigger qualitative risks or pushbacks a bank might point to in such a case? Thanks!
Glad to hear, John! As with any model presented to an investor, they are likely to scrutinize your operating assumptions (growth rate, margins), and a bank will want to make sure that the amount of debt you are taking on (Debt/EBITDA) as well as the repayment assumptions (e.g., mandatory vs… Read more »
plz share the excel template
Hi, Sidharth,
The link to the Excel template is in the article: https://s3.amazonaws.com/wsp_sample_file/2013/Quick-LBO-model.xlsx
BB
I did not get the year 2 to year 9 debt schedule computation for optional paydown.
Hi, Church,
Do you mean the logic of the formula? Basically, you take existing excess cash (existing cash minus minimum cash) plus the free cash flow available after the required paydown, and that is how much is available for optional additional paydown.
BB
Does this analysis ultimately mean that company XYZ is undervalued and that is why the financial sponsor is able to pay a healthy premium today to buy out the shareholders? Thanks
Hi, Dasola,
That is correct!
Brad
The equity value upon exit is less than its current market cap and we would be paying a premium. Why would you do this?
Elliott:
The equity investors are only putting in 6,080 to buy this company. At exit the equity value is 14,844 which represents a 33% IRR. This is a very good return and is an example of how an LBO can be profitable for equity investors.
Best,
Jeff
Absolutely brilliant, I want more
Ruri:
We have multiple in-depth examples. Search for LBO on the Home page and you will find several LBO Modeling “tests.”
Best,
Jeff
I am wondering when you calculating optional paydown for 2013E (second video 3:18), you add back current cash balance $100, but shouldn’t that $100 be used to retiring current debt? So when calculating the highest price to buying the company, we subtract net debt($500) rather than debt($600). We can’t use… Read more »
Coco: No, we aren’t necessarily using the $100 to retire debt upon the purchase of the company. After the existing debt is paid down (it doesn’t matter if it’s from new debt or existing cash), then we can use any excess cash to fund our new debt paydowns. For example,… Read more »
Very clear. It’s really helpful, thank you!
Awesome, thank you!
excellent and concise
Steve:
Thanks!
Best,
Jeff
I have one question about the calculation of cash in the second video. The cash left is the remaining cash from the previous year+cash earned-cash paid. Why the cash paid only include optional debt paydown not a required paydown of 1,000?
Isabella:
This is just a simple/quick LBO model where the Free cash flow after required debt paydown already considers the required paydown; it is not explicitly modeled in this example.
Best,
Jeff
Hi, why are we using the exit equity value and then looking for the maximum return in 4 years in question #3? (to the 4th power)
We are looking for the maximum amount of equity the sponsor can invest to make it’s required rate of return.
Best,
Jeff
Why are we using the equity value from the exit year and not the entry year?
The initial equity value depends on the exit equity value and the required rate of return. We have to backsolve for the initial equity value based on our expectations for exit value and necessary IRR.
Best,
Jeff
I am confused. At the end of video 2, the ending LBO Debt in row 51 is 11,291.2 in 2014E. Then, in video 3, it is 11,241.2. Why are we taking out a minimum cash balance twice?
Kendall:
If you watch closely, the number becomes 11,241.2 at the end of video 2 once we calculate our cash balance. We are only deducting out minimum cash once, not twice, otherwise our cash would drop below $50 in row 41.
Best,
Jeff
Has the debt calculation included the interest? It was not mentioned at all in the calculation.
Yes, interest was implicitly included when calculating Free cash flow after required debt paydown.
Best,
Jeff
Hello, what buttons did you press on the keyboard to calculate present value using 25% IRR? so what im asking what do you press to get the inverted V symbol?
Tariq:
Shift 6 gives you ^ on a US-style keyboard.
Best,
Jeff
Does the “required cash paid down“ in cell C38 refer to the same “required cash paid down” in B38?
Pamela:
There is no required cash paid down in cell B38. If you are talking about required debt principal paydowns then, no this is a different concept and calculation. In this model we simply assumed $1000 of annual required debt paydown.
Best,
Jeff
Do you have any video on Project Financial Modeling ie to determine the financial viability of a proposed project (before embarking on it)?
There is a new methodology called Engineering Finance used to enhance the ROI of projects and ensuring its long-term sustainability… can you elaborate on it?
We have two webinars on Project Finance modeling and are working on a course that covers project finance but as of this date, is not currently available to the public.
Best,
Jeff
So helpful and clear! love it.
Very interesting. I hope you will make the videos easy to download so that one can watch them offline over and over again.
You nailed it. I can’t wait to watch the next videos.
Thanks a lot.
Hassan,
If you sign on as a user for our Premium Package, you can download all of the videos for offline viewing – thanks.
– Haseeb
Thank You Sir,
The video very useful.
The LBO model with example is more easy to understand rather than reading the process.
And I think overall process of LBO analysis with decision making was covered in this video.
AM VERY GRATEFULL.
Thank you for the quick revision of LBO model….happy to have this free service
at 4:08 of the second video (debt schedule), Why is the free cash flow value taken from end of 2013 rather than the start (2012A) ? i.e. why 528 and not 420?
MH:
You would always use the free cash flow generated in the year you are modeling the debt paydown. The $480 from the previous year has been used on something (remember we only have $100 in cash on the balance sheet so that $480 had to go somewhere).
Jeff
please can i access this videos on youtube so i can download for references.
Rowland,
Here’s the Youtube link – thanks:
https://www.youtube.com/watch?v=paBl20MIXxQ
Thank you for sharing this video on how to run a LBO analysis. It was very helpful and definitely offers a macro view on what such an analysis would capture. In a real life LBO analysis, how does one choose a stock price to base the analysis on? is this… Read more »
For a public company that is the target in an LBO, it’s based on an offer price coming from the sponsor, which may be offered at a premium over the trading price. PE firms try to back into a suitable equity offer price that will hopefully ensure they meet their… Read more »
Hi I just become a subscriber to wall street prep you send me the quick lesson: simple LBO model and I can not download the excel template I get the nonsense pages, sense I got the premium from you, I just want to make sure I won’t have problem with… Read more »
Jay,
Please reach out to [email protected] for any technical issues – thanks.
Best,
Haseeb
Hi,
How come you subtracted 1 from the current share price when calculating the premium in the last question 3?
Jalal,
If we just took $39.96/$30, we would get 1.33; the way you would interpret this is that the implied LBO share price is 33% above the current trading price. We subtract 1 so that we just obtain the premium, which is 33%.
Hey, Looking at the 2nd video, didn’t you miss the initial $600 debt for the starting debt on D48? Meaning that your starting debt balance at the beginning of 2013 is the 14,400 from the loan PLUS the 600 from the period before. Please let me know if this is… Read more »
Rod,
We exclude that 600 b/c that’s the debt from the old structure (i.e. pre LBO). The new debt is the $14.4bn. Hope this helps!
Best,
Haseeb
Nice simple and clear presentation
There is a spelling error in your primer — first paragraph under Exit Assumptions
Josh,
Can you refer to the specific place in the paragraph? Thanks!
Best,
Haseeb
. . .rental income down the ‘raod’. . .
Good catch – thanks!
Hi,
I am not able to access the videos. I only see the titles of the videos.
Marina – please reach out to to [email protected] for technical assistance – thanks!
hey, i dont think the videos are showing up.
Ben – please reach out to to [email protected] for technical assistance – thanks!
Just 1 thing: In the comments section, in front of row #48 (LBO debt, beginning of period), you have written it as LTM Debt * LBO Debt Capacity. I think it shoould be LTM EBITDA * LBO Debt Capacity…
Thanks for the catch Varun – appreciate it!
Great work and I would like to get you to PNG to develop a finance school if possible.
Looking forward to the next lessons in Financial Modelling!
Thanks!
Hi Administrator,
Thanks so much for the first lesson.
Hope to see subsequent lesson.
Regards,
Thanks – appreciate it!
Hi there,
I could not get access to the video. Any chance to check the tech issue?
Thanks!
BR
Jean
Jean,
The videos are fully operational.
Shannan
Hi,
What is the keyboard shortcut to copy your formula across horizontally to the end of the data? For example, at time 7:15 in the first video.
Thanks,
Marcel
Hi Marcel,
The instructor is using a proprietary The Boost Add-In, an all-in-one suite of time saving keyboard shortcuts, formatting, and auditing tools designed specifically for people who build financial models in Excel. You can find more details here (https://www.wallstreetprep.com/blog/boost-add-in-for-excel-now-available-free/). Check it out!
Shannan
Ctrl right Ctrl Enter after you enter the formula in the first cell
Hi Mat,
Would you please tell me how to download this video for an offline review?
Regards,
jd
Hi Joe,
These videos can not be downloaded.
Hi, I have a question on the required paydown of $1B per year. You are taking the debt from $600MM to $12.8B. Wouldn’t your interest expense go way up, and bring your FCF way down? Where are you getting the $1B every year to pay down the debt (or, for… Read more »
Hi Jonathan, Great instincts! Your interest expense would increase and drive available FCF down as compared to previous periods. This is a very simplified version of a model where we’ve made simplifying assumptions to highlight the basics. Our LBO course takes an actual deal and thoroughly models it walking through… Read more »