LBO model-Management Rollover Equity-Sources and Uses-Urgent

Appreciate it if anyone could help....Thanks..

In a LBO transaction with mgmt rollover:

The EV is $100, debt on target B/S is $50, cash on target B/S is $10, the equity purchase price (or equity value) is 100-50+10=$60

Assume the mgmt previously held 100% stake of the Target, and it now wishes to trim its holding by 80%, i.e. rolling over 20% equity.

Assuming:
*New debt raised=$50 (just a random amount, not related to the $50 debt on target B/S)
*Using the $10 cash on B/S as a source
*The $50 debt on target B/S is refinanced
*No transaction fees.

I am wondering if method A or B is the correct one.

Method A

Uses:
*Refinanced Debt: $50
*Purchased Equity: $48
(Equity Purchase Price x Proposed disposal % by mgmt= $60x80%=$48)
*Mgmt rollover: $12
(Equity Purchase Price x Proposed rollover % by mgmt=$60x20%=$12)

**Total Uses: $110

Sources:
*Cash on target B/S: $10
*New Debt Raised: $50 (just a random number)
*Mgmt Rollover: $12 (same as the $12 in uses)
*Sponsor Equity: $38 (a plug to force Total Uses=Total Sources: 110-12-50-10=$38)

**Total Sources: $110

With Method A, after the transaction, the mgmt. should have a 12/ (38+12)= 24% stake in the target, instead of the proposed 20% rollover %.

Method B

Uses:
*Refinanced Debt: $50
*Purchased Equity: $48
(Equity Purchase Price x Proposed disposal % by mgmt= $60x80%=$48)
*Mgmt rollover: $12
(Equity Purchase Price x Proposed rollover % by mgmt=$60x20%=$12)

**Total Uses: $110

Sources:
*Cash on target B/S: $10
*New Debt Raised: $50 (just a random number)
*Total Equity Contributed: $50
(a plug to force Total Sources=Total Uses: 110-10-50=$50)
OF WHICH: Sponsor equity: $40
(Total Equity Contributed x Proposed disposal % by mgmt=50x80%=$40)
OF WHICH: Mgmt rollover: $10
(Total Equity Contributed x Proposed rollover % by mgmt=50x20%=$10)

**Total Sources: $110

With Method B, after the transaction, the mgmt. should have a 10/ (40+10)= 20% stake in the target, equating the proposed 20% rollover %.

Again, my question is which one is correct, A or B?

 

A.

also you are confusing the term "rollover" with "pf ownership", they are not equal.

also, you dont show management rollover as a separate line item in uses. its just 60 for "equity purchase price"

 

Thanks very much!

But now, I am wondering what would be the proper way/ wordings to describe what I wrote before:

“…the mgmt previously held 100% stake of the Target, and it now wishes to trim its holding by 80%, i.e. rolling over 20% equity…”

Pls suggest the correct wordings.

Uses: *Refinanced Debt: $50 *Equity Purchase Price: $60 **Total Uses: $110

Sources: *Cash on target B/S: $10 *New Debt Raised: $50 *Mgmt Rollover: $12 *Sponsor Equity: $38 **Total Sources: $110 This S&U should be correct now, right?

Million Thanks!!!

 

Correct wording would be: management is rolling over 20% of their equity stake in the company into the new PF entity. The Uses should be broken up into the 48 and 12 because if you just use 60, you may get some people confused. It's not wrong but just more clear to write it like I wrote above, that way people can see that only 48 of the 60 is being bought out with cash and the 12 is being rolled over, as opposed to giving the impression that 60 is being paid for in cash.

It's just optics, but will make it clearer for others.

 

Cash in an LBO is like matter / energy in thermodynamics - it can neither be created nor destroyed.

If sources > uses, then where did the extra cash go? If uses > sources, where does the money come from?

 
DaCarez:
Cash in an LBO is like matter / energy in thermodynamics - it can neither be created nor destroyed.

If sources > uses, then where did the extra cash go? If uses > sources, where does the money come from?

Well done. +1 when I have points again.
Get busy living
 

Seriously dude? You subtract 1 from any growth/return/etc calculation. If I have $100 at the start of the year and $110 at the end of the year, my return is 10%, not 110%

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

Both my earlier suggestion and HarvardOrBust's will suffice. It probably depends how they are marketing the Company. I.e. if they say the balance sheet is free of debt and cash - my earlier suggestion would be best. If they inlcude the $50 of cash but only indicate the buyer will need $25 to operative the Company - HavardOrBust's suggestion would be best.

PM me if this doesn't make sense.

 

Theoretically it is correct and makes sense but practically I have never seen it. Actually, at my firm we are usually conservative regarding sources and uses and usually we assume we should fund with equity injection whatever is not covered by debt. We usually don't even treat cash as potential source because before you actually make acquisition, you can't access this cash or be sure that it is not locked up due to lenders' restriction or some other accounting or tax trap. So in most our acquisitions sources consist only of equity and debt.

For acquiring public companies it might be different, not sure - I only acquired private ones.

 

Yes, it comes down to preference. You can show cash as a source and gross debt as a use; or choose to just show net debt. It will make no difference in the returns.

I like to show net debt. In my mind it is more intuitive as any existing cash on the seller’s books will be used to pay down existing debt. This point helps answer your second question – if debt > cash, then the cash will be used to pay down what it can of the debt balance and the remaining debt will be paid off by the proceeds from the sale. In the rare case that cash > debt, the debt would be paid down from the cash balance and the buyer would keep the cash that remains in addition to the proceeds from the sale.

In both of the above scenarios, the buyer is left with a company that has no debt and no cash – hence, “cash free / debt free”.

There can be nuances like minimum cash, also known as operating cash. This would show up as a use and is typically provided by the seller as it is required to operate the business.

 

Thanks, grainflow that's helpful.

your example where cash > debt helps illustrate exactly what I am trying to understand in terms of deal mechanics and who keeps what. in terms of original purchase price calculation, an offer is typically based on multiple of ebitda to get to an enterprise value for the target. from there the walk to equity value would be larger number given that cash > debt. since the uses side will have a net debt that is negative, does this serve to effectively lead to a total uses number that is smaller than the previously calculated equity value. i've laid the two scenarios out below and for simplicity assume no fees and full equity used to acquire firm (realize that both these are insane given LBO tag but trying to understand specific concept); i'm most particularly interested in the second sources and uses table (assuming both are laid out correctly) as it results in what i mention above:

Transaction summary EBITDA $10.0 Multiple 10.0x TEV $100.0 Cash 50.0 Debt (20.0) Equity $130.0

First scenario, where debt is shown in full and cash as a use Uses
Equity 130.0 Debt 20.0 Uses $150.0

Sources
Cash from b/s 50.0 Sponsor 100.0 Sources $150.0

Second scenario, where net debt is shown in uses: Uses
Equity 130.0 Net Debt (30.0) Uses $100.0

Sources
Cash from b/s -- Sponsor 100.0 Sources $100.0

i realize that sponsor equity in both cases are equal and below the calculated equity value in the transaction summary, but wanted to get your input on the total uses number also being lower in the second case. take your point that certain minimum cash needed to operate is more like a working capital item and is therefore fundamentally included in enterprise value and should be contributed by seller. thanks again for your help i think i am 99% of the way there in being fully comfortable on this!

 
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