Structuring a LBO
Olivier Levyne
Principle
• In the case of an industrial purchase, the multicriteria
valuation the firm is the first step…
• … before any analysis of the financial consequences of such a
transaction
• In a LBO transaction, the valuation of the firm is the outcome
of the structuring
 the firm has a specific value in a LBO context
Valuation of the firm in a LBO context
Target
Holding
100%
Value of
Assets
Equity
value
of the
target
Equity (H)
Shares
of the target
Financial
leverage
Debt (H)
Debt
• It is the maximum price that can be paid by the ad hoc holding the
financing of which is twofold:
– Debt financing, ie long term loan granted by banks
– Equity financing, ie capitalisation by private equity funds
Debt financing
• Maximum debt that can be repaid by the holding, provided
that its net cash balance (ie cash and cash equivalents –
overdrafts) is always positive
– Otherwise, it would mean that the holding has to run into
debt before the end of the LBO which would constitute a
breach in one of the covenants
• When the LBO is structured, the cash balance is equal to 0, as the whole
cash is invested in the target’s shares.
• Then, its cash balance is changed by the cash flows generated at the
holding level
• If the cash (ie the net cash balance) becomes negative, it means that the
firm has to use overdraft to face its financing needs ie a new indebtedness
is required
Holding P&L
•
•
•
Dividend received from the target
Tax received from the target
(Tax paid)
_______________
Net profit
As it is an adhoc holding, it has no assets other than the target
shares and cash (and potentially intangibles such as transaction
costs which have been activated)
For this reason, its main income is the dividend paid by the target.
Moreover, for tax optimization purpose, the target and the holding
are tax consolidated:
– The interests paid by the holding are tax deductible
– But the holding has no taxable income because the dividends
are tax free (except for 5% of the amount received). Then, the
deductibility of interests can not be used, whereas the target
has taxable profits
– The tax consolidation enables the use the deductibility of the
interests paid on the acquisition debt. Then, the tax saving
enables to increase the cash flows of the holding and therefore
the amounts of debt repayments
– From a practical point of view, the target and the holding sign a
tax agreement whereby:
• The target pays to the holding the tax which should have been paid
to the Tax Authority
• The holding pays to the Tax Authority the corporate tax based on
the consolidated income for the whole tax group
Holding cash flow
• The Holding cash flow can be directly derived
from the net income
Net profit
+ Depreciation (ie: 0)
Amortization
Capex (ie: 0)
 D WCR (ie: 0
Debt repayment
_______________
Cash flow
– It owns no tangible assets which would have to be
depreciated (only the activated transaction costs, if
any, have to be amortized)
– It is not supposed to invest before the end of the LBO
– It has no WCR as it is not dedicated to trade purposes
• It has to repay the acquisition debt
Acquisition debt conditions
• The A-tranch (80% of the senior debt) has to be
repaid over a 7-year period:
– Flat payments or progressive payments
– Cost = 6 months Euribor + 225 bp
• The B-tranch (20% of the senior debt) is a bullet
debt
– Full repayment at the end of the 8th year
– Cost = 6 months Euribor + 275 bp
• A 100 bp additional cost of swap (to hedge the 6–
month Euribor floating rate) has to be taken into
account
Holding balance sheet
• Assets:
Target’s shares
Net cash balance
____________
Total assets
Equity
Financial debt
_____________
Total equity and liabilities
– The book value of th target’s shares is
hopefully flat: its decrease would
mean that they have to be
depreciated because of losses which
would have an adverse impact on the
LBO
– The cash is changed, every year, by
the cash flows
• Shareholders’ equity and liabilities
– The equity is increased by the net
profit (no dividend being paid by the
holding as the whole available tax is
dedicated to debt repayment)
– The acquisition debt is reduced by its
repayments
Equity financing
• The private equity fund require a 20% minimum IRR
• Notations:
– V0 = investment of the private equity fund in the ad hoc
holding
– Vn = value of the group (ie: holding + target) when the
private equity fund will sell its holding shares
• Vn can be calculated based on an EBITDA or EBIT multiple:
Vn = EBIT multiple x EBITn – net consolidated debtn
• If the average duration of the investments is 3 years,
then: V0= Vn / (1+20%)3
Appendix: Balance sheet of the target
Fixed assets (n)
WCR (n)
_____________
Total assets (n)
Fixed assets (n+1) = Fixed assets (n) + Capex (n+1) – D&A (n+1)
WCR (n+1)
= WCR(n) + DWCR(n+1)
_____________
__________________________________________________
Total assets (n+1) = Total assets(n) + Capex(n+1)-D&A(n+1)+DWCR(n+1)
Equity (n)
Provisions (n)
Net debt (n)
_____________
Total equity and liabilities (n)
Equity (n+1)
= Equity(n)+Net profit(n+1) – Dividend(n+1)
Provisions (n+1) = Provisions (n)
Net debt (n+1)
= Net debt (n) - Cash flow (n+1)
_____________
________________________________________________
Equity &liab. (n+1) = Total equity & liab.(n)+Net profit (n+1)-Dividend(n+1)
-[Net profit(n+1]+D&A(n+1)-Capex(n+1)-Dividends(n+1)
-DWCR(n+1)]
= Total assets(n) + Capex(n+1)-D&A(n+1)+DWCR(n+1)
= Total assets (n+1)