LBO Question - 5-7 years is the exit year

Not too sure, but shouldn't that depend on future cash flow/deleveraging?

Best,

SoulSearching

thanks soulsearching. but i mean, how would you determine that in a model? from what i've seen, they've generally just made an assumption.

Great! thanks for that explanation. It really puts things into perspective. BTW, does anyone have a link/tutorial on LBO model or anything that will help to better understand how they're valued?

Generally, you have to assume the sponsor wants at least a 20% IRR. Typically, 25% is the norm and usually they'll do some work (acquisitions/restructuring etc) to get it higher. You're exit is also influenced by market conditions, if you need to close the fund from which you made the investment, etc.

Value creation encompasses the following - at exit, assuming it deleverages (not a given, I've looked at deals where 3 years later leverage is the same or higher given acquisitions and crap performance) by having cash as a greater % of the capital structure than when you entered the transaction and by assuming EBITDA/multiple expansion (e.g. you bought the company for 10x EBITDA which was say €30m. 3 years later you're hoping the industry/growth prospects of company/whatever has led to margin uplift so now when you sell it the company will be bought for more than 10x, and you're hoping that EBITDA has grown.

much thanks!

Not to make things more complicated for folks here, but as a clarifying point it should be noted that the end game for creating equity value in an LBO is not necessarily achieved through de-leveraging a company.

In fact, there are a number of reasons that a very successful investment may have the same or higher levels of debt at exit than it did at entry. Years ago, the fund where I currently work did an acquisition for ~$3.0 bn in enterprise value -- roughly $2.6 bn of this was funded with debt while the balance ($400 mm) was funded with equity. At the time of the acquisition, the company's LTM EBITDA was ~$400 mm. Two years later the company's EBITDA had grown to ~$500 mm, and we were able to issue additional subordinated notes for ~$400 mm.

Essentially, we were able to get out 100% of our initial equity investment through a recap within two years (because the additional sub debt accrued PIK interest and sat below all other debt, the other senior creditors had no issue with the recap). Total leverage on the deal relative to EBITDA was similar to what it had been at close; however, we had received 100% of our principal investment while still holding the same controlling equity interest in the business.

While a riskier strategy, the most efficient use of capital in an LBO is involves re-leveraging, and not de-leveraging, a portfolio company.

altho i'd like to see you guys try that with us in these mkt conditions!