Devising Capital Structure for LBO Model Tests
All, I wanted to ask about how you estimate the different tranches of debt for an LBO model. For example, when there isn't any information in the prompt, what assumptions do you make for revolver, first lien and second lien? My overall debt assumption would be 4 - 6x EBITDA. I would start with an undrawn Revolver, a then a term loan of 4x EBITDA, but not sure where to go after that. Also how do you determine interest rates? I know SOFR is at 4.3% right now, so do you just do S + 200 for revolver, and S + 400 for term loan and call it a day? Thanks
First, if they give you any info on the company would tailor the total quantum a bit (i.e. you're not getting 6x on a small industrials biz in the current market but you might on a larger HC biz). Would generally stick with the same spread on both your revolver and your TL and market spreads rn are more in the S+525-625 range. Depending on size could just use a uni structure but if you want to make your model look more complex could then add a 2nd lien which you would usually assume as a flat rate 12-14% and potentially some of that PIK'd (12% cash + 2% PIK is relatively common to see in model tests).
Thank you so much!
You need to solve for what your company can afford and it’s easy to back into.
What is EBITDA - Capex? Not two years out or funny adjusted EBITDA, a defensible LTM amount. This is your back of the envelope cash flow available for debt service. What DSCR do you want? Let’s say 2x. EBITDA - Capex / 2 = maximum interest burden. Now you have how much interest your business can service (with some built in cushion) and can determine how to slice it up.
How do we do this? A quick way is to pick a total cost of debt and divide interest by it. If 10%, then interest / 10% = total debt quantum. You can then use that amount to check the leverage ratio output and see if that makes sense relative to your entry EBITDA multiple and LTV expectations.
Does your business have a lot of receivables and inventory? Make some discount assumptions and pack an advance rate, and now you have your borrowing base for an ABL which will have a cheap cost of capital (+250-350). How much total bank leverage do you want? Let’s say 4x…take 4x minus how much ABL you want drawn and the delta is what you backfill with a bank loan at say +450-550. How much interest / leverage do you have left to allocate from the above envelope quick check? It’ll probably solve to some teens type of coupon…you can either decide to have that as a Mezz or just turn the bank loan into a unitranche with higher rate.
All of these inputs can be quickly sensitized to see the impact on your exit IRR / MOIC ratios and can also help you figure if a deal is financeable in like 5 minutes of work.
Congrats, you don’t need a cap markets banker anymore please pay me their 2pts in bananas.
very helpful, thanks!
Could you do this analysis excluding capex. On this logic you would not see many SaaS deals with more than 5.5x 1L debt given where rates are in Europe and of course you see 6.0x 1L leverage in deals. And yes I am aware that capex is low in SaaS businesses.
Yes, but just because you can doesn't mean you should. I see plenty of software credits with 5-6x leverage on EBITDA and 2-3x DSCRs (just on EBITDA) touted as rock solid, but EBITDA misses a lot of real expenses in SaaS businesses. For example, most SaaS businesses capitalize commissions or other customer acquisition costs instead of expensing them, which overstates P&L. On a net basis, your DSCR may actually be closer to 1x which doesn't leave a lot of room for error in operations.
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