LBO - financing fees
Dear All,
I can't seem to get my head around how financing fees are dealt with in a LBO model.
Given that financing fees are capitalised and then amortized on a balance sheet when does the business actually part with the cash?
For example, there are financing fees of $10m which is amortised over 5 years equally. We would see the following:
Income statement - an amortization fee expense of $2m each year (non-cash)
Cash flow statement - as this is a non-cash expense, it would be added back to net income to derive cash flow from operations
Balance sheet - we would capitalise the financing fee in year 1 under non-current assets as $10m and then amortise it by $2m each year
So when does $10m of cash actually leave the company? Every post and text book I've read so far doesn't actually say when the cash leaves the business.
Also to clarify, are other fees such as M&A advisory, accounting and legal subtracted from shareholders equity?
Thanks in advance.
Best,
The cash is paid to lenders at closing of the transaction. But the tax benefits are realized over a 5 year period (hence amortizing it annually for five years).
So how would this impact the financials statements?
Just to add on - it seems there's a new rule of FASB on not to capitalize financing fee but instead to just have carry value of debt lower by the financing fee amount?
Could someone please explain how should financing fee be now modeled in a LBO model in terms of debt schedule portion and the interest expense portion that feed into I/S?
Thanks!
Financing fee is now treated as a contra liability and amortized over the years
You are correct that the accounting rules have changed the classification of financing fees as a contra liability. The ultimate amortization and accounting would remain the same as before.
Basically :
Income Statement:
Interest: Year 1: ($2m) Year 2: ($2m) Year 3: ($2m) Year 4: ($2m) Year 5: ($2m)
Net Income: Year 1: ($2m) Year 2: ($2m) Year 3: ($2m) Year 4: ($2m) Year 5: ($2m)
Cash Flow Statement:
Year 1:
($10m) financing fee paid to banks
Year 1: $2m Year 2: $2m Year 3: $2m Year 4: $2m Year 5: $2m
Balance Sheet:
Cash:
Year 1: ($10m) Year 2: Year 3: Year 4: Year 5:
Debt:
Year 1: ($8m) Year 2: $2m Year 3: $2m Year 4: $2m Year 5: $2m
Retained Earnings:
Year 1: ($2m) Year 2: ($2m) Year 3: ($2m) Year 4: ($2m) Year 5: ($2m)
I understand that debt is the way it is in order to balance the BS. However, I don't understand the intuition behind it. Why is debt going down by 8 in year 1 and consistently increasing by 2 for the remaining four?
M&A etc fees is a positive adjustment on the uses of funds side, so they are effectively added to the amount of equity a sponsor needs to pay.
Although i have seen transactions where PEs wanted the sell-side to incur these costs (unusual).
You're saying you've seen situations where the PE firm acquiring the target wanted the seller to pay for the PE firm's use of an M&A advisor?
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