LBO Valuation IRR

Could someone please, please explain how PE houses target an IRR to value a company. Really don't yet know the basic steps for an LBO valuation. Would be grateful if someone could please explain.

Many thanks.

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Comments (7)

Dec 2, 2017

Very Basic:

An LBO is like an triangle where you plug in two sides to get the third side.

The three sides are IRR, Entry EV and Exit EV

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Dec 2, 2017

Thanks for that. That triangle analogy does help.

So if we want to get Entry EV (for valuation purposes), we need a target IRR and Exit EV. How would you get the Exit EV though? That I'm assuming would depend on cash flows and an exit multiple (which people say is normally similar to the purchase multiple). Do you determine the exit multiple using what comps?

Thanks.

Dec 2, 2017

The exit EV is often estimated by taking an exit multiple (EV/EBITDA) multiplied by forecast EBITDA. PE firms will aim to exit via either an IPO or trade sale (sale to a competing company or another PE firm). The comparable exit multiple can be based on listed multiples if aiming for an IPO, or trade sale comparables. The listed comparables will generally have higher multiples, which is why you see a lot of 'roll ups' where PE firms buy smaller privately held companies in the same area for 5-9x EBITDA, grow the group and cut costs, before listing it and selling it at a 10-12x EBITDA.

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Dec 2, 2017

Perfect. Thanks for that sean833!

So would these be the steps to value a company using LBO approach.

  1. Target an IRR (e.g. 25%)
  2. Project company's future FCFs to work our EBITDA at exit. Using trading comps, find exit multiple to work out EXIT EV.
  3. Accounting for debt interest repayments and any principal repayments and the projected FCF, work the Maths backwards from the exit EV to work out the entry EV.
  4. The entry EV is the max the company is prepared to pay to achieve the certain level of IRR. So therefore LBO valuation usually gives a floor valuation as PE houses are financial buyers rather than strategic buyers.

Could you (or someone else) please confirm that these are the steps for an LBO valuation.

Thanks so much

Dec 2, 2017

That sounds like you've got the right idea. Although, generally the buyer will identify the EV they need to pay first. Then after this determine the potential exit value and the resulting IRR.

Buyers will often need to pay a higher amount and accept a lower IRR if there is a competitive bid. So in reality you would consider an IRR range based on the initial price and then a range of potential exit multiples and EBITDA results.

Also, don't forget that the IRR is calculated on the equity invested (equity value not enterprise value) and equity returned to the PE firm after paying off any remaining net debt on exit. In the IRR calculation you also have to include any distributions made to equity during the investment term.

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Dec 2, 2017

Yeah makes full sense, thanks for that.

In order for the PE house to identify the purchase EV, they will have to value the company right?

Could you please explain how an LBO Valuation works? How would they value the company to get to the purchase EV?

Thanks

Best Response
Dec 4, 2017
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