Reason for extremely high IRRs
Hi all,
I've built a few LBO models recently in order to prepare for a case interview and for some reasons every model resulted in a 5-year IRR > 40% for investors and I just don't get why since these numbers seem to be too high to me.
I think that I've incorporated the concept of shareholder loan not correctly. Would anyone be so kind and have a look at my model? It's kept very simplistic which is why is should be easy to understand.
Many thanks! Wouldn't know what to do without you since my interview is scheduled for next Monday and I don't have anyone else to ask..
Best,
Andy
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lbo_model_test_sow_08mar16_v4.xls 38.29 KB | 38.29 KB |
Didn't go it in depth, but just from the face of it a non-exhaustive list:
Cheers
Didn't go too in depth either, but a few things that popped out immediately:
*Also, where is this growth coming from? Keeping EBITDA margins and capex relatively flat on a % basis (i.e., not investing above historical rates in sales and marketing, capex, R&D, G&A to support the growth) is unlikely for at least the first couple of years. If you find business with that kind of growth rate, that doesn't require significant additional investments, it's even less likely you'll buy it for 7x. (If you do, please let me know so I can invest)
This is more a matter of philosophy and many people do model exit multiple the same as entry, but you may want to model exit multiple ~1.0x less than entry. Even small companies can't sustain 20% topline growth and certainly not without investing in other areas, so exit multiples should reflect that. Of course there are a lot of other factors that come into play like better margins, competitive advantage, M&A environment at the time, type of business (SaaS vs. capex heavy manufacturing), etc. But I don't think it'd be overly conservative to expect some level of multiple contraction.
You're not including refinanced debt in your uses (and therefore sources) table. You can either show the uses as buying the equity + refi debt separately, or as enterprise value in one line. It's optics but in any case, you need to include debt somehow.
Tax rate of 25% is low, should be at 40% unless there are NOLs. Though from the looks of the currency symbol, you might not be in the US so ignore if not applicable.
Many thanks both of you for your hints! I took those into account and did some changes to the model and now end up with ~27% investor IRR (5 years) which looks much more reasonable.
Main reason for my questions were actually whether some of the model mechanics were wrong. I know that such a strongly growing business with flat EBITDA margins is not very likely. Also the multiple discussion is correct.
Two questions are left: 1. @Waving wind: Can you please point me towards the line where I miscalculated the equity valueand what is wrong there? 2. Shouldn't management returns usually be higher than investor returns? In my case it's the other way round and I wonder why. Does anyone have an idea or could point me towards the important parameters to look at in order to evaluate this?
Thanks so much!
P.S.: I updated the attached Excel model.
Very cursory glance. First thing that jumps out: You're treating treating the shareholder loan as both equity and debt (netting it from EV in your calculation of equity value as if its debt but simultaneously giving the investor credit for it as equity in your cap table).
That's why you see the massive discrepancy between mgmt IRR and investor IRR and your returns look so fcked up.
Thanks, found the mistake! Great help!
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