Interview questions on LBOs
What are the main drivers of LBOs for private equity returns?
What are the main drivers of LBOs for private equity returns?
+136 | How to stop feeling like shit for not making it in IB? | 52 | 6h | |
+102 | If Tik Tok is forced to sell, what banks do you think would be involved in the deal? | 49 | 8m | |
+66 | Updated LA Banking Scene (2024) | 49 | 9h | |
+57 | Why Is It Called Investment Banking? | 19 | 17h | |
+38 | Ranking banks that went under | 19 | 11h | |
+32 | A strategy for SA applicants late to the game like myself | 15 | 17m | |
+31 | UBS Actual Buyside Exits 2024 Post-Integration | 9 | 3d | |
+30 | Burnt Out M&A ASO | 15 | 1s | |
+29 | Relevance of A-Levels for U.K. London recruiting | 21 | 8h | |
+26 | Series 79 Help / Tips to Pass The First Attempt | 11 | 1d |
Career Resources
leverage.
If ever, when investor demand for high yield debt and junk bonds returns, to maximize LBO IRR just before exiting:
If the target has accumulated NOL's, it could be carried over to Acquisition-SubCo, thus helping taxes, and freeing up cash flows to aggresively pay down debt.
Try to pay down as much debt as possible by "focusing" the firm by selling off unrelated & underperforming units. The market always rewards "focus" and industry leadership. The #1 and #2 players in any industry, always have much higher P/E multiples and command higher valuations.
*You don't want to completely pay down the debt, implying an unlevered firm financed with 100% equity, because such a firm is not optimal, and won't command maximum value, that's why the F500 Co's continuously issue bonds and commercial paper to maintain optimal debt levels that maximize shareholder value, so always maintain optimal debt on the target's books until you exit, and reap your returns.
Goodluck on the interviews!
good input. can you explain why companies with low leverage make more attractive targets? I've seen an explanation on here before but i found it was not very compelling.
^ Low leverage = better credit ratings = lower interest rate on secured, unsecured loans, and lower coupon rates on the junk paper. Also, collateral such as industrial PP&E, land, and real estate on target's B/S makes it much easier to attract lower rates on the secured debt portion.
I don't know why they would come up in an interview unless you've actually worked on those kind of deals/models.
But it's usually a debt ratio (around ~30%) at which the weighted average cost of capital is fully minimized, so firm value is maximized.
It is calculated by evaluating the Rwacc (ReL, Rd*(1-t)) at various D/E ratios and plotting a graph to find a minimum point.
For various D/E ratios: 1. You get an expected interest coverage ratio 2. Getthe expected credit rating 3. Then get the expected cost of debt from moody's/s&p 4. Then get the cost of equity using the CAPM for each D/E ratio. 5. For each D/E get the WACC.
Plot a graph of ReL, Rd, and Rwacc.
What you'll notice is that as leverage (D/E) goes up, ReL and Rd will go up, as expected.
But, the Rwacc is unique, in that instead of increasing with leverage, initially from 0% leverage, the Rwacc actually goes down, then reaches a minimum.
The D/D+E ratio at which the Rwacc is at a minimum is the optimal capital structure for that firm, and is usually around 30% leverage. Also, because the Rwacc is minimized, at this point firm value is maximized.
You're saying that after 30% leverage, Wacc starts to go up? For firms generally?
I'm very skeptical about this. Wacc will often continue to go down well beyond 30% leverage, because debt at those levels (even now) is often cheaper than unlevered equity. What makes wacc turn upward is the expected cost of financial distress (ie bankruptcy) which is exceedingly difficult to estimate. The cost of bankruptcy itself can be estimated, but the probability multiplied to it is anyone's guess. Not enough comparable firms with comparable capital structures go bankrupt under comparable market conditions to give you a reasonably good predictor.
Corporate finance academics (the ones I've read) are virtually unanimous in that there is no way to conclusively arrive at an "optimal" capital structure - for many more reasons that I've outlined above.
I understand lower credit ratings = lower interest rate on secured but once you lever it up to 7-8x EBITDA won't you loose all that and wouldn't it come out to the same as if you would have bought it already levered at those levels?
A company has finite debt capacity. Targets with lower existing leverage have higher debt capacities targets with higher existing leverage. You cant LBO a company if you cant lever it up from existing levels. Make sense?
i see what you're saying, but isn't it the case that the acquirer will often pay down the existing debt and refinance it with new debt, thus making the current debt levels less relevant? or does this all vary from one situation to the next?
what kind of leverage do you think people will be able to get in m&a deals nowadays? i mean, do you think people will continue to get 3-5x senior, 2-3x sub? if not, where do you see it going?
Rerum et praesentium accusamus. Aut consectetur libero numquam est ratione. Nihil et aut inventore est consequatur numquam esse.
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...