Why do private equity firms want to invest the least amount of money into a deal? Don’t private equity firms have a lot of money to invest? Yes. Isn’t it because they want to diversify their holdings? Maybe. But, the real reason is math. By that, I mean that mathematically you generate the highest relative returns when you invest the
Equity can come from two primary sources in LBO financing. The amount of sponsor equity that is usually invested is the difference between the total uses and the maximum amount of debt capital the firm was able to access. Total Uses – Debt = Equity The private equity firms invested capital is called sponsor equity. The management’s invested capital is
The goal for private equity firms is often to take on the greatest amount of leverage that the company can handle. By handle, this means that the company should have enough cash flows to service any interest and principal repayments and then some in case things don’t go as planned. Sponsors think about the maximal amount of debt by projecting
How should we treat financing fees in an LBO? Financing fees are any upfront costs associated with issuing new money. Typically, whenever companies issue new debt, they must pay the lender a commitment fee of 0.25% to 2%. Even the financial sponsor may charge fees on total sources less fees in contributing capital to close the deal and organizing the
Is interest the only cost of issuing debt? No. Interest is important as both the lender and borrower. But, lenders have other ways to increase their returns. Aka other fees. One such fee is the commitment fee. This fee ranges from 0.25% to 2% of the loan amount. So, if you were to take on a loan of $100M, you
Distressed companies are distressed because they are unable to meet their covenants, or rules placed by lenders, on their debt obligations. For some companies, this can be because they overlevered and do not have the ability to have their operations cover their interest on debt. If this is the case, the company must restructure itself. Financially and/or operationally. Often, companies
Purchase Multiples versus trading multiples. What’s the difference? Trading multiples represent the firm’s current market value relative to a metric. The market value could be either that of the firm (market enterprise value) or that of equity (market value of equity). The metric could be anything that is correlated to the firm’s ability to generate cash flows. For example, if
Why do we need a Sources & Uses schedule? In an LBO, the schedule is the basis of the new capital structure of the pro-forma company (post-LBO). The capitalization of the business will change depending on how much leverage the private equity firm decides to put on the company to close the deal. The S&U schedule will indicate the sponsor
What are the sources? What are the uses? At its core, a deal is a financial transaction between two parties. If you are acquiring a company, you are exchanging capital for the business. In doing so, you need to first establish what is the amount of capital that must be transferred to the seller in order to acquire the company.
Options are not the same as shares. Many of my students think that 1 option equals 1 share. This is true on the surface. A call option gives you the right to buy a share of stock at a specified price by a given date. So, if you work for DropoutEdu and were granted 1 at-the-money option that expires in
