Hey guys - new user here with an interview coming up. Can someone help me understand how to use the balance sheet when assessing a company for a buyout? Especially when comparing two companies. For example, do I care about how much existing cash or debt is on the company? What about the assets it has?
I know I can understand the profitability and cash productivity of a business if I have the balance sheet over time, but those are two things I can more easily gleam from the I/S and CFS.
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In terms of caring about how much existing cash or debt the company has, sort of ... but a lot of transactions are structured cash-free debt-free or the target has covenants that require the debt to be paid off in a change of control situation to where the NewCo will have a very different Anatomy from the OldCo. I think when looking at the balance sheet, it’s easy, when dealing with transaction adjustments and sources/uses of funding, to forget what the main purpose is: buyout a good asset. With this in mind, I would generally focus on two fundamental things: assets that can be pledged as collateral and independent funding capabilities. Assets are intuitive: we ideally want to buy a company that has assets that enable us to take on leverage because they serve as peace of mind for lenders. In terms of independent funding capabilities from the scope of the balance sheet, I’m talking about a company that isn’t heavily reliant on external financing, debt or equity. For example, if we see a company that is constantly taking on new debt on the balance sheet because it can’t cover its operations and expenditures, then we know this wouldn’t be a great buyout candidate because the new debt we put on the company would be difficult to pay off which means our equity wouldn’t be growing, especially in the case where we’re not assuming multiple expansion. We want to identify assets that don’t need a lot of debt raises or follow-on offering to continue operating because this means they have the most room post-transaction to lay on new debt.
Adding to the point above, you can also look at the net working capital requirements of the business to understand how much cash the business generates or consumes as the business grows or shrinks. If you can formulate any initiatives to improve the NWC during your holding period then you get a cash payout benefit.
Mainly when looking at balance sheet I look for a couple of things:
1. how much working capital does the business need and is if positive or negative?
2. Are there any bombs / mines?
ex. Pension liabilities, ppp loans, earnouts, big in funded tax liabilities, etc.
Thanks for this. Could you explain how PPP loans could potentially be a bomb?
Can you expand on importance of working capital?
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