OID in LBO Modelling
I've seen OIDs accounted for a couple of different ways in LBOs and wanted some clarity on how you guys think about it.
Let's say the term loan used to finance a buyout is $100m, 99 OID, 2% financing fee. Under Sources, I would show the $100m TL. Under Uses, would the corresponding fees be $1m OID + $2m financing fees = $3m financing expenses? And then we'd amortize both over the life of the loan?
Just trying to understand best practices for modeling. Thanks guys!
Depends. OIDs can amortized in a variety of ways: as a bullet at maturity, amortized over the life of the loan, etc. The exact details will be the term sheet.
^This and also remember to increase debt principal as you amortize, and deduct the proportional amount from the OID when you pay down each year.
I think best practices depends on bank. For us, we normally show the debt under sources as 99, so net of OID because it more clearly shows what actual cash source is available (and we'll label "Acquisition Debt, net of original issue discount" in the table). Grouping it with financing fees is strange, as it's not technically a fee or expense. The other option is to show it under uses as a separate line, but it's normally small enough that it's...weird to show that way.
Either way, not much of an issue as long as the model results are the same. Just a presentation thing depending on how your MD/client likes to see it.
Really helpful, thanks.
A quick follow-up - how does this balance when you flow through the I/S? If I have $10 in OID amort in a given year @ 20% tax rate, my NI would be down $8, cash up $10, then OID balance is down $10 and debt balance is up $10? It's not balancing so I think I'm missing something
Cash: NI -8, add back 10 = net +2 Debt & Equity: Retained Earnings -8, Debt +10 = net +2
And btw, not sure if you're doing this, but the debt balance that goes on the PF balance sheet should be 99. You don't normally show the OID on the balance sheet, just the debt balance, net of OID
Thank you! Can you just help me understand how to interpret your earlier statement below in light of this? Does OID not sit on the B/S too as a contra-liability?
^This and also remember to increase debt principal as you amortize, and deduct the proportional amount from the OID when you pay down each year.
It is technically a contra-liability, but most balance sheets just show the debt, net of OID. So if you want to separate it out on the balance sheet for modelling purposes then:
Cash: NI -8, add back 10 = net +2 Debt & Equity: Retained Earnings -8, Debt 0 change, OID -10 (so liabilities +10 since it is contra) = net +2
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