Hi all - posting this in PE because I used to work in PE and you guys are better modelers than Corp types. Doing buyout model work for a firm that has a large revolver facility. They can do small to medium size deals of say $30-$150m entirely with revolver funds, so no equity check up front. How would you deal with this in the IRR calculation? I can't isolate sponsor returns with zero upfront outflow because IRR pukes without a negative flow upfront. So I have to look at firm returns with the entire purchase price outflow upfront (all debt funded) right? But then, do I need to subtract net remaining debt from the terminal value to isolate the sponsor returns? This doesn't seem right either, feels like a double-count. Thanks for any help.
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Maybe you are over complicating the model? I would think if you are using a revolver, you just be using any free cash flow to pay down the revolver + interest.
I don't think you can accurately calculate the sponsor returns unless there is a full exit.
We kind of pretend there is a full exit. Either using an exit multiple or more commonly a perpetuity to derive a terminal value. So the DCF ends up with the all debt purchase price up front, 5 years of UFCF, and a terminal value. We have typically not been subtracting net debt from terminal value, and running an IRR on the whole thing. But I started to question this practice and now can't figure it out.
Are you trying to get to some ROE? If I'm a PE firm that LBO'ed a platform company, which later uses its revolver to buy bolt-ons, then upon exit of the entire pro forma company, I'd assume the PV input would be my initial equity check that I wrote and the FV would be total enterprise value less net debt at exit. Buying add-on companies using all debt is very common in PE and illustrates the power of leverage in enhancing equity returns. If you're just trying to isolate what the ROE is on the add-on that's fully funded with the revolver, I'm not sure what the point of the exercise is since it's a free option to the equity... maybe use -$0.01 as your PV, lol.
Yes, that's a great example. That's essentially what this situation is - a platform company buying bolt-ons at 100% leverage and we want to know the IRR of the bolt-ons. We look at dozens of targets each quarter so need a common way of comparing across them, and have been using a classic DCF format with (purchase price) + 5yrs UFCF + year 5 TV and running the IRR on that without subtracting any remaining net debt from the TV. I don't think we're going for an ROE view, just NPV and IRR, almost like any other capital investment project. Now that I'm writing this out, it seems clear that subtracting net debt would be a double count, because it is already "subtracted" in the purchase price. Does that sound right?
If you're just trying to compare the attractiveness of targets all 100% debt financed there's no reason you need to look for IRR to equity. Why not just compare them on return on capital over financing cost?
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