Sources and uses
Hi all,
One element in banking/modelling I have constantly seen people dont understand is sources and uses, including myself. I have obviously modelled with it many times, but my understanding is purely mechanical. Therefore I want to see if anyone in here will be able to help me once and for all :)
Lets use a very simple example: say a target has an EV of 100$ with 20$ in cash and 60$ debt on BS. It is financed with 70$ sponsor equity and 50$ debt (assuming minimum cash balance of what they currently has on BS). This gives a S&U of:
Sources:
Equity: 70$
Debt 50$
Uses:
Net debt: 40$
Minimum cash: 20$
Equity: 60$
Some questions on this as I believe it is the cash element that is confusing:
- What happens here/what will be the difference if they decides to pay down the debt rather than refinance/roll over the debt?
- Why do we use net debt in the uses rather than the gross debt?
- What mechanically is happening with the debt and cash at settlement?
- If we assume no minimum cash balance, what happens with target's cash and debt at settlement then, and would only the net debt be included in the uses still?
- I have seen multiple times that some uses the target's cash in the sources - what does that mean and how is that possible?
Hopefully someone here can answer this, many thanks!
Best,
K
Hi Associate 1 in IB - Gen, any of these threads helpful:
More suggestions...
Fingers crossed that one of those helps you.
How I'm reading your assumptions, this is how I would structure the S&U:
Sources: $70mm sponsor equity funding, $50mm newly issued debt
Uses: $60mm equity purchase price ($100mm EV + $20mm cash - $60mm debt), refinance $60mm of existing debt
It's cleaner to take cash out of this (not a net debt number). To answer your questions:
1. There would be a difference if you pay down debt rather than refinancing it. If you have $20mm of cash, you can only reduce your debt by that amount, bringing your debt to $40mm and your equity value to $60mm. The cash belongs to the equity holders, so they wouldn't want to pay the debt down pre-transaction
2. Not sure I'm following- rephrase? I don't use net debt
3. Not sure I'm following- rephrase?
4. Cash belongs to the equity holders. If the acquirer doesn't want to pay equity or issue debt to acquire cash (you're acquiring all of the equity, which equity owners own the cash, so indirectly acquiring equity), then you would use target co's cash as part of sources
Following
You already showed S&U with the debt refinanced. If you roll it you put it on both sides of S&U.
1. If the debt is rolled over, the existing debt of 60 would show up in both sources and uses. If debt is being refinanced, the existing debt of 60 is paid down (shown in uses) and immediately replaced with new debt of 70 (shown in sources).
2. Most people use gross debt, actually. Instead of having 20 of cash go towards reducing existing debt, it should go towards the min cash requirement.
3. If there is no min cash requirement, the 20 of existing cash will become a source and will reduce the sponsor equity. The S&U would look like this:
Uses
Refi Debt: 60
Purchase Equity: 60
Total: 120
Sources
Cash: 20
Debt: 70
Sponsor Equity: 30
Total: 120
4. In this case, the 60 you spent to purchase the equity includes 20 in target cash. So you can use this 20 to help fund the transaction. It's akin to spending $120 to buy a wallet that is worth $100 with a $20 bill inside.
Fundamentally looking at it the wrong way. The purchase price governs the sources and uses, not some arbitrary definition of theoretical enterprise value.
Throw MS all you want. You guys are glorified typists.
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