Is IRR always the ultimate deciding factor when looking at LBO Financing Structure?
Would IRR in your lbo model always be the deciding factor in determining which financing structure to use for an LBO or would other factors come into play?? For example would an IRR of 22% using senior and senior stretch debt be the same as using senior and mezz debt if the IRR is also 22%? Also is there a huge advantage to using all senior & senior stretch debt and in what situations would it be most appropriate??
You're probably trading off covenant flexibility with mezz debt versus a lower interest rate with the stretch senior. Mezz might be PIK interest, while senior will generally be cash interest. You're unlikely to end up with the same amount of stretch senior versus mezz; mezz will go deeper into the capital structure.
If you end up in the scenario you describe, that last bit of mezz is probably really expensive...i.e. as expensive as equity in your base case. I say that because if you assume the same company/purchase price, additional debt is generally enabling you to finance a greater % of the purchase price, therefore shrinking your equity account and improving your IRR.
KingKong Thanks for the insight. In a scenario where you are worried about meeting debt repayments would you consider taking a lower IRR for a less risky finance structure? Lets assume you create a sensitivity analysis in which your down state you may have trouble with debt repayments, would you consider a less risky financial structure even if creditors allow a greater max leverage??
Doesn't matter what banks are willing to lend. In your case, really sounds like lower leverage is the solution.
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