Debt Paydown in an LBO Model
Hi all,
After an LBO occurs, how much of the free cash flow that the company generates will be used to pay down debt? Will the PE firm opt to use all of the free cash flow to pay down as much debt as it can? Or will it only use a certain portion of it and use the rest to pay partners and satisfy NWC requirements?
Thank you for any help.
The lenders negotiate what is called an "Excess Cash Flow Repayment" requirement. Essentially, the lenders force the company to use a percentage of the excess cash generated by the company in a Fiscal Year to pay off additional debt. Usually we negotiate this to be about 50%.
what compbanker said, typically there will be an excess cash flow recapture provision in credit agreements. Typically between 50 - 75%. Sometimes leverage governed with step downs in future years.
There's also something called a Restricted Payments Basket, which governs how much money can be paid out of the company (e.g. dividend).
What this means that even if a company generated $500 million of FCF and they are required to sweep 50% of FCF to paydown debt, they'll have $250 million left to play with. That remaining $250 million isn't "do whatever you want with it"-money since if the RP basket is $75 million, the most you can pay out of the company is $75 million. The RP basket generally prevents the company from paying dividends to the equity holders, pre-paying sub debt, etc... essentially acts reducing value held at the company at the senior debt holders' expense. It makes companies retain (1-Mandatory FCF sweep%) as a cushion.
In the current market environment however, borrowing is getting pretty cheap and covenants like RPs, are easing up.
The fun of the game is negotiating the definition of excess cash flow to minimize cash used to repay debt and maximize cash available to dividend.
I believe the technical term is called a "Cash Sweep" option whereby any excess cash reserves on the company's balance sheet (in excess of normal working capital requirements) are automatically used to pay down debt. Again, the cash sweep is something that can be negotiated with the banks.
Debt paydown in the MM is usually 2 components: 1 is the amortization schedule that is negotiated into the credit agreement - maybe 10% of initial term loan balance per year. The second portion is the ECFR, which CompBanker described above.
Amet eum quo laudantium fuga. Ipsam officiis tempora rem libero. Iste ut at voluptatem. Minus et rem tempore blanditiis culpa.
Nihil et suscipit ut aspernatur aut sit quaerat. Voluptatem quisquam molestiae distinctio non laboriosam aspernatur.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...