Debt for LBO?

chips_ahoy's picture
Rank: Baboon | 139

Hi guys:

May I ask a quick question on debt for LBO please? I'm doing some practices and would really appreciate your guidance!

Assuming I'm doing an LBO of a public company, levering it up to 5x EBITDA...there are a few things I'm confused about the debt component:

1) How much revolver do I assume I can get? Is that linked to EBITDA?
2) How do I think about what kind of tranches of debt I can get? I know total leverage is usually 4-6, but how do I know how to divided it between Term Loan, bond, 1st lien, 2nd lien etc? How do I know what amortization schedule and interest I can get in this market now? Would appreciate your guidance!

Comments (7)

Mar 21, 2019

Quick background, the purpose of a Revolver is to be self-liquidating in distress. So it is Not EBITDA linked but collateral linked.

Revolver should advance 80-90% on qualified AR. Inventory really depends; you can borrow near 100% on gold, maybe 80% on copper and 50% on steel (the liquidity of commodities). Assume Raw, geez, anywhere between 20% (custom materials, composition and size) and 100% depending on how re-saleable it is. No advance for WIP inventory as no body wants a half-built anything. FG should just be shipped as they are hard to value.

Revolver will have a first lied position on AR and INV. (short term liabilities on ST assets).
Term note on your longterm assets, generally your M&E. Terms depend on the deal, figure a 10 year Am with maybe a 5 year note. Pricing is aggressive these days. L+1.5?
Mortgage on your real estate. 20 years.
Mez will take a second position.
Bonds, I'm just not familiar. I believe they are all cashflow based and not collateral based.

Hope that helps

    • 4
Mar 21, 2019

This is only true, if you are using ABL financing for revolver. A/R generally ~85% advance rate, Inventory depends heavily on the nature of inventory. (e.g. food is probably lower advance rate). However, there's cash flow lenders as well that look at EBITDA. Even as ABL lender, we have EBITDA covenant in place to avoid company's from over leveraging. This all depends on how bankers structure the deal, there's a lot more flexibility in the agreement when it comes to bigger deals. For example, if it's a sponsor deal, then the company may have 7x leverage. Revolvers are usually used as working capital. While long term asset are usually used as term loan collateral, however real estate and M&E can also be used as revolver collateral. All depends.

Since, revolver are senior debt, pricing is usually better, therefore cheaper way of financing for companies. Next up is investment grade securities, typical company bonds with higher rating. Pricing probably depends on the market the risk of the deal. Usually done from the investment grade debt capital market desk.

After investment grade debt is high yield or junk bonds. This is usually done by leveraged finance. These are usually sponsor deals or distressed companies. It is the most expensive way of financing on the debt side. It's more complicated as the case by case scenario is never the same. Sponsor deals are usually easier to do overall because they know exactly what they want and what they are looking for. EBITDA leverage depends on the risk appetite of the bank, for example WF are known to have low risk appetite, while I have seem some BB doing 7-8x EBITDA leverage.

Lastly, most companies that are well run and higher grade usually don't use ABL financing, and will lean toward cash flow lenders. Companies that use ABL financing are usually companies that have hard time getting a credit product base on cash flow, therefore they turn to use their A/R and inventory. This is why ABL do a lot of sponsor deal or do deal in partner with lev fin more often than investment grade DCM.

    • 3
Mar 21, 2019

On the A/R advance rate, generally 85%, not 75%

Most Helpful
Mar 22, 2019

To answer your question in a case study situation, you can generally use these rough guidelines:

In general, total leverage should be roughly 50-75% of the purchase price.

The "EBITDA leverage" (Senior / Sub notes) you use depends on the nature of the business. If it's a cyclical retailer or consumer products company, a lender wouldn't be comfortable with more than 3x-4x because in a downturn you'll easily trip your covenant as EBITDA declines. If it's an asset-intensive manufacturer in a defensive industry, you can get up closer to 6x. Given where we are in the economic cycle though, I wouldn't offer up any more than that or you'll get some tough questions back from the interviewers.

(ABL) Revolver - The guys above summed this up well. If you're an asset-intensive business (lots of inventory) then you'll probably use this because it's cheap. If you can't use an ABL revolver, then just input a normal one for the debt schedule but don't draw down for the acquisition.

Senior Debt - 3-4x, priced between 5% - 7% interest

Subordinate Debt - fill the remainder of your EBITDA debt assumptions if needed, priced around 10% PIK interest

As a sanity check, add a couple credit metrics (Debt / EBITDA, interest coverage, fixed charge coverage) to demonstrate that you're in compliance with the typical maintenance covenants

    • 5
Mar 21, 2019

Can you elaborate on how pricing from a DCM or Lev Fin side is done and any information that you can provide in the type of modeling they do?

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Mar 22, 2019

Unfortunately not because I work in M&A, so the general pricing I gave above is just from experience getting leverage reads on our deals. Again, it all varies by the type of company and industry.

Mar 22, 2019
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