Last summer I worked at a small boutique bank that worked primarily with small private companies (the lower end of middle market). Interestingly enough, the MD (one of two MDs at the entire office) said that they have primarily been using leveraged recapitalization models as opposed to DCF model or other valuation practices (precedent transaction/comparable comps) to determine the value of the companies they worked with.
They said that the primary reason for this is that clients understand it much better, and it's much simpler and more transparent compared to the DCF. They also cited common pitfalls of the DCF (unpredictability of cash flows, sensitivity in choosing the discount rate, etc).
I suppose it makes sense, but I really could not find any information on leveraged recapitalization models in use for valuation... could anyone offer more insight? I will be having interviews soon and I am sure they will ask about this.
You sure he didn't say lbo model?
I see what you mean. For clarity's sake, just gonna note that LBO implies change in control; leveraged recap does not.
For OP: if you look around for LBO concepts, advantages, and disadvantages, I think you should find better answers already posted than I could sum up quickly. Ultimately, an lbo model will tell you "how much can I pay" vs. a DCF, which will tell you the theoretical valuation of an asset.
Leveraged recap model is the same as LBO - they are just buying back their own shares as oppose to another company.
Leveraged Recap (Originally Posted: 02/12/2013)
If a company brings on debt and equity in the same round... then uses the proceeds to partially payout one shareholder, how does that affect the fully dilluted ownership for the rest of the shareholders?
bump
It depends on how it is structured. If the new equity buys out the existing shareholder as a secondary, then nothing happens to the fully diluted ownership of the rest of the holders. Then, if they issue debt and use those proceeds to buy back some more of the existing equity, ownership of the other shareholders increases, all else being equal (makes sense, since you have lower shares outstanding, so each investor's % ownership increases).
But, if you're doing an equity raise, then doing a debt raise, and then doing a buyback later on, it gets slightly more complicated. Here is a very simplified example.
Assume I have 100 shares in a company, investor A owns 80%, Investor B owns 20%. I do a follow-on, and bring in Investor C, to whom I sell 25 shares, so he owns 20% of the pro forma company.
25 investor C shares / 100 shares outstanding pre offering + 25 shares from follow on
At this point, Investor A owns 64% of the pro forma company, and investor B owns 16% (20% dilution).
Investor A: 80 / 125 pro forma shares outstanding = 64% Investor B: 20 / 125 pro forma shares outstanding = 16%
If I issue debt and use that cash to buy back some of Investor B, position, the fully diluted ownership of the rest of the shareholders should increase. Let's say I buy back 10 shares from investor B.
Investor B: 10 / 115 pro forma shares outstanding = 9%
Investor A: 80 / 115 pro forma shares outstanding = 70% Investor C: 25 / 115 pro forma shares outstanding = 21%
This is a very simplified example, but hopefully it's helpful in how to think through the math.
What do you mean by, "25 investor C shares / 100 shares outstanding pre offering + 25 shares from follow on"? Thanks.
You sell 25 shares in the equity raise. That goes in the numerator (investor c shares) and in the denominator (total shares outstanding )
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