So I'm working on an LBO model now of a family-owned business where the family will retain a sizeable minority share post-acquisition. I modelled out sources and uses based on a certain amount of debt, but according to my boss, it's not correct to use 100% of the debt to lower sponsor equity, since the equity value of the minority shareholder reduces on a like-for-like basis?
Instead what my boss suggested was to add in an additional use of cash that represents a cash payment to the minority shareholder, which was calculated by % minority stake * debt amount. This naturally increased the sponsor equity required considerably.
I wanted to ask if this additional use of cash is commonplace? I understand the intuition behind it, but I've never seen this included in an LBO of <100% of a business. Thanks
S&U shouldn’t have “added items” but reflects reality. EV=100 (assume debt-free company pre-LBO, 100% family owned), assume debt financing is 60 so equity financing is 40. Family retains 30% stake in the business ie value at 12 post-LBO.
Sources: Debt 60, sponsor equity 28, family roll: 12
Uses: family cash out: 88, family roll: 12.
What he said on the S&U is accurate ^
Family will get the same benefit from the leverage put on the business as the sponsor. Fairly straightforward I would think.
Thanks for the reply. Trying to understand a bit more about the math behind it - how do you get family cash out of 88? The pre-transaction equity value is 100 and you're buying 70%, wouldn't that be 70 then?
Asking this as there are financing fees that will come into uses of funds too. Apologies for the basic question.
The equity post-LBO is worth 40 and family has 30% so their value is 12. They owned 100% of 100 pre-LBO so they cash out 100-12=88.Think about extreme cases: if family cashes out 100%, you raise 100, they cash out 100, they roll 0, they own 0.
Missed point on financing fees. Those should be added to EV and are a simple addition to sponsor equity, assuming sponsor bears them. In reality you don’t care if seller bears costs as it will not affect funds flow.
Thank you, that clears it up!
This isn't about "benefit" that family gets (what does that even mean?). This is about ownership. Does the family want a fixed % ownership or fixed $ ownership? If fixed $ the plug is sponsor equity. If fixed % the plug is sponsor equity and family rollover in ratable portion based on fixed %.
Simple as that.
Youre not wrong but missing the point. The point is that the family ownership (regardless of a proportional or fixed roll) is calculated post debt (assuming the debt is placed on the company rather than on the specific equity tranche blabla)
Uh what? That point is so obvious it doesn't even need to be said. The dude's boss is implying the family means to own a certain % since the minority stake is being ratably reduced.
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