LBO - Seller's Note?

Banker88's picture
Rank: King Kong | 1,826

Just took an LBO modeling exam for an interview and had a question. Part of the financing was a seller's note at 0.5x leverage (in addition to a revolver and term loan). I was fine with setting up the sources and uses, but was not sure how the seller's note gets treated in the debt calcs and IRR.

The exam said that the seller's note gets paid out only if EBITDA reaches a certain level. Does it get included in net debt that gets subtracted out to reach equity value in the exit year? Or if it gets paid out then what happens? Thanks.

Comments (4)

Best Response
Jul 10, 2012

It's not clear from your description:

1) Typically, a sellers note means a PIK loan, which is treated just like debt. In this case, maybe there is a cash payment if EBITDA exceeds a certain level. That means it is just a regular loan where the cash interest/PIK/principal repayment depends on EBITDA

2) However, if it is structured as an earn out i.e. the seller loses his money if EBITDA target is not reached - typically it is not in net debt but is treated as a claim on equity at exit i.e EV-Net Debt - Earn out = PE funds equity on exit.

I hope this makes sense.

    • 2
Oct 14, 2018

Can someone explain answer #2 a little more thoroughly? I appreciate the answer but it's still not clicking for me. Some clarification would be appreciated as I've never heard of an instrument like this before.

Oct 16, 2018

Earn out is pretty much like a subordinated note to the equity (GP/LP if the equity is snydicated), it's still paid out but just not at the top of the waterfall like senior debt. Should be very expensive given its place in the cap structure...

Feb 7, 2019
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