LBO - Seller Note, how to model S&U and 3 Statements

Took a model test recently, that included the transaction being funded with a 1.0x contingent seller note. this note is assumed to be paid out in full (at exit) if seller meets a certain ebitda target at exit, and is payed out at a certain % between a range of EBITDAs. Does this show up on S&U? Also how would you model out this note at exit if the target is hit / not hit. If it is not hit does it turn into sponsor equity or how does that affect sponsor returns ?

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Comments (8)

Feb 2, 2018

monkeyseemonkeydo1234, sorry there are no responses yet. Maybe one of these topics can point you in the right direction:

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If we're lucky, the following users may have something to say: @mitchebo24 @Keepman @mmwillis14

Hope that helps.

Feb 5, 2018

Hey, I figured the top comment on this thread might be of use

https://www.wallstreetoasis.com/forums/lbo-sellers...

Feb 5, 2018

Yes, it's in the S&U as a source of financing (it's just like debt).

In the returns, you'll subtract it from your TEV to get your equity value using IF statements tied to EBITDA.

Oct 10, 2018

What's the actual "point" of this instrument in general? The downside is that you don't get paid back for the principal of the note, but the upside is higher because you get a % of EBITDA?

Oct 10, 2018

The point is to share some of the risk of the transaction with the seller.

From the buyer's perspective, the seller still has skin in the game by allowing some of his payment to be contingent on ongoing performance of the business.

From the seller's perspective, this might increase the total multiple he can get for the business in exchange for offering the buyer some downside protection.

Example: Seller wants an 8x multiple, buyer offers 7.5x. Seller agrees to accept 7.0x plus a 1.0x note. Things go well, seller gets his 8x and buyer is happy to pay it. Things go south, everyone shares in some of the pain. It's a good way to align incentives.

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Oct 10, 2018

Makes perfect sense now. Thank you.

Feb 7, 2019

This would mean that the note is only repaid at exit. Would there ever be a case that the earnout is paid during the holding period?
- If so, this would be like option debt paydown. If cash falls below the min balance, then revolver would make up for the difference. What if the revolver hits a cap? The negative cash balance would mean the company is insolvent.
Is there a way to avoid that? Would it just be easier to stay with the earnout being paid out at exit?

Feb 8, 2019