Revolver Accounting in Interview LBO Models
Been looking at some hand-me-down LBO templates and solutions to cases that some friends have sent me and I noticed that most if not all ignore a maximum commitment on a revolver. I feel like its fairly easy enough to model that restriction in the Drawdown / (Repayment) section of a debt schedule but was wondering if I should even bother doing so?
To my understanding the numbers should work well enough in a case that the firm is not expected to ever need to draw down on the revolver over its commitment. Also, if my cash flow for debt service is a negative amount greater than my revolver commitment, wouldnt I have negative cash flowing through the rest of the debt schedule? How would one go about solving such a scenario if they were to stay true to the revolver cap.
Thanks!
The revolver is drawn upon in the event there is not enough cash flow from operations to service debt. If the revolver is maxed out then there would no other sources of cash to service the debt, thereby putting the company into default in most cases.
LBOs ignore the commitment size because every Company should assume they can refinance for a higher commitment amount with similar pricing once they outgrow their current revolver if they are growing at a steadily profitable rate. Let me caveat that they should be outgrowing their revolver 3-5 years out not in the next 12 months to 18 months. If their projections call for a bigger revolver in the next 12 -18 months then they should refinance it at close in conjunction with the LBO transaction for a higher commitment amount. And if their projections are calling for a bigger revolver commitment within the next 12-18 months you should probably consider the viability of those projections relative to their historical performance. If they're considerably higher than what they've done historically then higher pricing than what they're currently paying should probalby be assumed.
To answer your question about the negative cash when the revolver is maxed out... You need to add a another debt/equity tranche below the revolver that solves for minimum cash. I typically call this "Principal Equity" or "Haircut Capital". It's basically the additional equity that's needed to fund management's forecast or plan that you're modeling. It's not a good thing when you need this capital, but again consider whether they need this capital in 12 months or 4 years. If it's the latter you could assume they would have refinanced their revolver by then for a bigger commitment thus not needing the haircut capital.
Thanks a ton for this. Both aspects of your comment were incredibly insightful especially as it pertains to Principal Equity
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