Tough Technical Question on Rollover Equity

I recently encountered the following question and was a bit stumped. If any of you monkey's are able to lend a hand it would be much appreciated.

Assume that the Sources & Uses is for the purchase of a company in which 100% of the shares are acquired and 100% of the existing debt is retired. Contingent Notes refer to a contingent obligation based on the performance of the company after the acquisition and are part of the acquisition consideration.

* Debt: 125
* Target Company Cash: 20
* Equity: 91
* Contingent Notes: 19
Total Sources: 255

* Purchase Shares: 85
* Retire Existing Debt: 160
* Transaction Fees: 10
Total Uses: 255

There are 35 million shares outstanding of the target company, 10% of the shares are rolled over, and all of the contingent notes are issued to current equity holders. What is the total cash paid to shareholders excluding the cash paid for shares rolled over?

Comments (4)

Most Helpful
Oct 27, 2019 - 9:53pm

I'm a little rusty, so please excuse if this is way off base, heh...

First, I would split out the amount of target equity that is being rolled over. Based on your prompt, this looks to be 10% of $85, or $8.5. You can add this to your "sources", and the remainder is the amount of equity getting bought out. I'm assuming your "Equity" lines are a catch-all that includes both sponsor and rollover equity, which is why I split them.

Then, you can start by determining how much total cash in your sources you have, and then deduct from/allocate to your uses accordingly. Based on your sources, you have $125 of new debt proceeds, $20 of company cash and, assuming this is a sponsor transaction, $91 - $8.5 of cash from the sponsor. Assuming the $10 of fees are purely administrative (e.g., legal, advisory, financing, etc.), this all gets paid in cash. Then, to retire your existing debt, you utilize another $160 of cash. Excluding amounts leftover attributable to rollover equity and contingent notes, you will have the remaining cash available at close that can be distributed to non-rollover shareholders.

Said another way, that cash plus contingent notes should equal the value of the equity you are buying out. (It's a faster way, but wanted to show the steps)

  • Analyst 2 in PE - LBOs
Oct 30, 2019 - 8:17pm

Thank you for the detailed explanation, that was really helpful. I appreciate that you took the time to walk through it rather than just skipping to the end and giving the calculation. I think I understand but would like to confirm.

The reformatted sources and uses after breaking out rollover equity looks like this.

* Debt: 125
* Target Company Cash: 20
* Rollover Equity: 8.5
* Sponsor Equity: 82.5
* Contingent Notes: 19

Total Sources: 255

* Purchase Shares: 76.5
* Rollover Shares: 8.5
* Retire Existing Debt: 160
* Transaction Fees: 10

Total Uses: 255

We can take the total cash in our sources of 227.5 (Debt, Target's cash, Sponsor Equity) and subtract the total cash uses of 170 (Retire existing debt + Transaction Fees) and we are left with the 57.5 of cash that is being distributed to non-rollover shareholders.

Oct 31, 2019 - 3:45pm

Yep, you got it. That's how I looked at it based on your prompt. Here's also a breakdown of the other "quick" way I mentioned:

  1. There's a total of $85 in equity value in this transaction, but only 90% of this equity is actually getting bought out = $76.5. The rest roll and so receive no compensation.
  2. You know the equity getting bought out (the $76.5) is getting a consideration of cash and all the contingent notes for selling their shares.
  3. You're given the value of the contingent notes at $19, so $76.5 - $19 = $57.5 is the remaining consideration that must be paid in cash.

If you want to be cheeky, you can argue that the selling shareholders eventually get $76.5 in total cash, assuming the target meets all the terms of the contingent obligation later on, heheh.

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