Modeling Test: Option Pool Question

Hi All-

I've been working through some of the WSO LBO modeling tests from the PE guide. My question relates to the Basic LBO 2 model and the option pool. There is a dividend recap at the end of year 3 and the sponsor exits in year 7. A management option pool is exercised on exit. The formula for the cash generated from the management option pool is as follows:

=IF(exit equity > (entry equity - div payment ), option pool % * (entry equity - div payment),0)

My question is why is the dividend payment even coming into consideration? If the dividend is in year three, the sponsor is the only equity holder at the time. The options are executed in year 7, so I would think only entry equity and exit equity values would come into consideration - not what the sponsor earned along the way during the hold period. The way the formula is laid out reduces the amount of cash generated when management exercises the options. I modeled the cash proceeds from the options as:

=IF(exit equity > entry equity, option pool % * entry equity, 0)

Is this correct? Can anyone help explain this?

Thanks!

Comments (3)

WSO Monkey Bot

Rank: Human
13,427

Jan 23, 2019 - 5:18pm

Hey CEEBanker, the following topics might be helpful:

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Fingers crossed that one of those helps you.

Private Equity Interviews

OverlyAdjustedEBITDA

Rank: Gorilla
735

Jan 26, 2019 - 3:41pm

When a dividend recap occurs in reality, you typically adjust down the strike price of the options by the dividend amount per share in order to make the option holders whole and no worse off than if you didn't do the dividend. That's what that original formula in the template is reflecting.

Authored by: Certified Private Equity Professional - Vice President Certified Private Equity Pro