LBO: Net debt, excess cash, and Sources and Uses
Hi all,
I have been thinking about the treatment of seller's BS cash in LBO models and how Sources and Uses link with the Equity Offer Value. I'll create an example (for simplicity, buyer funds the entire purchase price with cash & no transaction fees).
Scenario 1
* Min. cash required: $5mm; BS Cash: 10
* Debt: 0
* EV: 150
Sources:
* Excess cash: 5 (10-5)
* Sponsor equity: 155 (plug)
Uses
* Offer value: 160 (150-0+10)
Question: In our Net Debt calculation, we add back the full amount of cash ($10); however, should we only add back the excess cash to get to the Offer Price? Phrased differently, why is the seller getting credit for the full cash balance when $5mm is required to stay with the Co.?
- Looking for an answer, I found that this Columbia paper offers an explanation on page 18: "The minimum cash is considered an operating asset, so is already part of the equity value and does not need to be added back to go from equity to enterprise value." Further, it says for Sources and Uses, "the minimum cash restricts the amount of cash that can be used as a source to pay selling shareholders." Is this saying that the seller gets full credit for the cash balance, and we, as the buyers, have to fund the minimum cash balance?
Scenario 2
* Min. cash: $5mm
** BS Cash: 2**
* Debt: 0
* EV: 150
Sources:
* Excess cash: 0
* Sponsor equity: 155 (plug)
Uses
* Offer value: 152 (150-0+2)
* ** Min. cash: 3** (min. cash req. 5 less BS cash 2)
Question: for the offer value, why are we giving the seller credit for the $2mm of cash that can't be extracted from the business? Is this because we're spending cash to buy cash?
I noticed that sponsor equity does not change in my proposed solutions.
Any insight is greatly appreciated.
Defining it as an operating asset is the key to this question: if for example the cash is in cash registers (and therefore is never available to financiers of the business) it is indeed part of the operating assets and therefore already included in the EV (Working capital actually, so you could do seasonality analysis and see if the current balance is higher/lower than average > if lower it is a debt-like item / if higher it is a cash-like item). If the company just had seasonality in cashflows, the balance sheet cash = cash for the transaction and you can use a RCF line with a bank to cover this.
So if cash is excess, you add it both to sources and uses (in addition to the EV, so equity value > EV).
Scenario 1 Sources: cash of 10, sponsor equity 150 Uses: min cash 5; equity value (150+10-5) 155
Scenario 2 Sources: cash 2, sponsor equity 150 Uses: min cash 5, equity value (150+2-5) 147
Cheers Rover. Very interesting point on the seasonality analysis.
To clarify, is the below S&U is correct for Scenario 1? I've seen excess cash appear different ways, and the result has been gaslighting.
Sources: * Excess cash: 5 (10-5) * Sponsor equity: 155 (plug)
Uses * Offer value: 160 (150-0+10) --> includes the excess cash
Almost, see my response above (added it to that post)
Rover-S If this were structured as a cash-free, debt-free transaction, do we assume the seller takes all the B/S cash in the business, and so it can't be included in the Sources side? Does the seller only take out the cash in excess of the necessary minimum cash balance (assuming it's just B/S cash the company would want to keep on hand to fund operations), or does the seller take all cash on B/S and sponsor must additionally fund minimum cash balance? (Or can it be done both ways)
E.g. in Scenario 1: Sources: Sponsor equity $165 Uses: Purchase price $160, Minimum cash $5
Thank you!
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