Shareholder Loan in LBO Case
Hi everyone,
Thanks in advance to your response to my question. I have come across a Shareholder Loan in a few practice cases and wanted to get some clarity about how to treat this. I'll provide a pretty simple example for these purposes. Let's say we have an LBO where the sponsor is contributing $200 in equity (the equity check) along with a $100 Shareholder Loan. We are told the Shareholder Loan has a "fixed interest of 10%" (no further detail about if this is PIK, cash or other).
At exit, let's say the TEV of the business is 500. Just to make things simple, aside from the Shareholder Loan let's say there is no cash and debt. Would it be correct to apply method (1), (2) or another altogether:
(1) Cash Interest
TEV = 500
Less Shareholder Loan = 100
Equity value at exit = 400
Each year, the sponsor receives 10 in interest on the Shareholder Loan. Let's assume a 5 year hold period.
MOIC = (400 + 100 + 10*5)/200 = 550/200 = 2.75x
Basically, the Shareholder Loan is treated like any other loan, and interest is also an inflow into the sponsor. Furthermore, we assume the Shareholder Loan principal is paid back to the Sponsor at close, probably by the new buyer.
(2) PIK Interest
TEV = 500
Less Shareholder Loan = 100 + 10*5 PIK interest = 150
Equity value at exit = 350
MOIC = (350 + 150)/200 = 500/200 = 2.5x
Basically, I am looking to validate if (a) the Shareholder Loan is treated like normal debt when calculating equity at exit, (b) the Sponsor receiving the principal in full at exit, assuming no other details on amortization of the loan are provided, and (c) if in absence of further details we would treat this as cash interest or PIK.
Thank you!
Denominator should be 300 in your calculation--sponsor's total outlay is 300.
Thanks for your help and that makes sense. Would it be fair to assume PIK or cash interest in a situation like this?
Wait why is it $200 and not $300?
This is based primarily on European deals from a few years back. I assume not much has changed since then.
Initial investment (Institutional strip) is 300 in your case. Typically, that structure would be more like 290 shareholder loan and 10 ordinary equity. Outside of the 10 there, you would have management, who get some ordinary or sweet equity. Some of management's equity stake will be in hurdle shares (or ratchets). That means they get more shares depending on an exit outcome (typically EBTIDA growth or multiple, IRR/MOIC etc)
Shareholders loans were always PIK and compounding. So, in your case: 100*(1.1)^5 ~ 161 is the final balance. 10% would be quite low as a rate. Typical PIK rate was 13%-17%.
Thank you. So it looks like, based on your explanation, the correct MOIC in my example would be:
TEV = 500 Less = 161 Equity: 339
MOIC = (339 + 161) / 300 = 1.67x
Of course this is simplified, but asking for the purposes of tackling this on a modelling exam. It does make sense to me now that 300 would be in the bottom, to keep things apples to apples.
Yes, that's correct. In your simplified case, it's always Exit EV/Initial investment given you have no debt or other shareholders. It sounds quite simplistic to be on a modelling exam.
SReaper So you treat the shareholder loan as equity for initial investment purposes? Is treatment essentially akin to how you would model like preferred stock, for example, then?
Yeah, basically for any instrument where the economics are the same the modelling should be the same. I think you may have some convertibility for prefs though that could have additional optionality. Would depend on the term sheets.
Consequuntur sed cum cupiditate et et error voluptates. Qui voluptatem nobis nesciunt velit rerum minus pariatur. Eveniet eius deserunt illum ut corrupti est. In hic autem odio dolore quia.
Aut sequi recusandae explicabo voluptas incidunt aliquid consequatur maiores. Voluptate sed laudantium atque aspernatur. Dolorem voluptas corporis quia sunt ab commodi. Adipisci sint ipsa voluptas quia debitis. Saepe incidunt labore in in voluptatem consequuntur. Neque dolorum quibusdam nobis ea.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...