Minimum Cash and its effect on Equity Value
HI guys, I had a question on how Equity Value is calculated in an LBO:
Let's assume I buy a company at 10x, with EBITDA being $100. So the Enterprise Value at entry is $1,000.
The company has no legacy debt The minimum cash required to keep the business functioning is $100. The company currently has $250 of cash on its balance sheet.
On the Sources side, I include $150 of excess cash ($250 - $100). This assumes that I sweep the balance sheet for excess cash to help fund the transaction.
Now on the Uses side, I record Entry Equity Value of $1,150 ($1,000 + $150).
After 5 years I exit the business, and have an Enterprise Value of $5,000. I have paid down all debt, but have $100 of cash left. To get from exit Enterprise Value to exit Equity Value, I subtract nothing because I am considering that $100 of minimum cash to be an operating asset. Therefore my Equity Value is $5,000 as well.
To me, this all makes perfect sense, but this is not how other models I've seen do it in their models. They use "excess cash" for the entry equity value calculation, but use "all cash" for the exit equity value calculation.
Can anyone confirm that I'm right in my methodology?
TLDR; In an LBO, is Equity Value at both entry and exit equal to 1) EV - Debt + Cash or 2) EV - Debt + Excess Cash?
bump
I think I understand what you are trying to do, but this is an unusual way to calculate equity value. You should compute equity value as TEV - Debt + Cash at both entry and exit.
At entry, if (i) the company has $250 of cash, (ii) you are fully funding the transaction with equity (i.e., using no debt financing), and (iii) you want to sweep the excess cash and leave behind just the minimum required cash balance of $100 at the company at close, then your S&U would look something like this: - On uses, you have $1,000 TEV + $250 cash which you are acquiring - On sources, you have $150 excess cash you are sweeping from the company to buy the company + $1,100 equity - i.e., In essence, you are contributing $1,100 equity to buy the company ($1,000 TEV) plus cash required to operate the company ($100 cash)
At exit, when you exit at $5,000 TEV with $100 cash, your equity value is $5,100.
What about if the transaction was done on a Cash Free Debt Free basis? Then would OPs calculation be correct?
In that case, S&U at entry would simply be 1,000 TEV on uses and 1,000 equity on sources. And at exit 5,000 proceeds to equity.
But the minimum cash is an operating asset, why would you subtract it from EV to get equity value in either case?
>this is an unusual way to calculate equity value
Going to have to disagree with this. Enterprise value is the value of the company's operating assets. By counting operating cash as "cash" and adding it to enterprise value you're overvaluing the equity.
I think you’re getting at the distinction between cash and operating NWC. i.e., To your point, I can see a case in which “Cash” is narrowly defined in a purchase agreement such that cash (lower case cash) is not factored in as Cash (upper case Cash) and instead treated as NWC. e.g., Cash in registers and not available to owners as referenced in the comment from Rover-S below. In that case (where the cash is really treated as working capital) I agree that the calculation required there would be a little different.
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