Why is Management Rollover not affecting IRR?!
Hi,
I have stumpled across an issue with the basic 30 Minutes BIWS Paper LBO Model (in case anyone knows it).
In that model, management is rolling over 10% of equity at exit.
Now, in the model this does not influence the IRR or MoM multiple, WHY?!
Simply stated, the 10% of equity that the management buys at the lower purchase price will no longer contribute to my Equity growth (or only contribute by purchase price x 10% of shares) and should hence diminish the money I receive at exit?
What am I missing here?
Thanks!!
Having some issues with comments loading so this may have been answered already. But in a very succinct way, it's essentially money you're not paying.
If a deal is priced out at 1,000mm and management is rolling over 10% of EV, then total financing from the PE fund would only be 900mm. While the total dollar value of the investment/return might be marginally lower because you're investing 900mm less your debt instead of 1000mm less debt, the actual %/multiple returns will be the same for the investors just on a smaller portion of capital.
Exactly, the IRR would be the same if it was all sponsor equity or mgmt (10%) and sponsor (90%). Only way mgmt could get a better IRR and the sponsor a lower one is if there was mgmt promote/options in which the mgmt would effectively be taking some of the sponsor's return.
Correct.
Read in on the envy ratio or sweet equity. Your statement only holds if all equity is equal (all ordinary equity). However in 90% of the cases the PE will provide a huge chunk of pref shares/pik notes to fund 90 or 99% of the equity, leveraging the actual returns of the remaining ordinary equity. If all goes well, management hits the jackpot. If company moves sideways, the pref shares earn 10% interest every year, "eating up" the ordinary equity of management.
Thanks for your answers! I was assuming that management has the possibility to buy the 10% rollover equity at the time of exit at a preset price per share, determined at the time of the LBO. I think that would be a Management Option Pool then. No it makes a lot more sense :)
Most PE firms don't work with (free) options as with a true equity investment of managers, they too have 'skin in the game' as they like to call it.
Hi All,
Sorry to reopen the topic but I still don't understand why it does not impact Sponsor Equity @ entry
Thanks a lot !!
It impacts the $ value of the equity funding for the transaction that is attributable to the sponsor (e.g. total equity $ - mgmt rollover $ = sponsor equity $), but the returns on all equity would be the same assuming no mgmt promote / options
Thanks for the answer - but if we want to calculate the sponsors CoC and IRR - aren't we suppose to take into account the roll-over?
Again, apologies for the question
If you and your friends put 100 into something today, you put 50, total proceeds at end of year N are 300, you will receive the amount that commensurate with your contribution, which is 150. MoM for each party will be the same, and IRR too, assuming payment happens at the same time. Roll-over is a similar concept...This is v straight forward...
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