Treatment of excess cash in sources of funds
Hi all, I don't quite understand that when calculating the sources of funds for an LBO deal why we include the excess cash of the company. This is reducing the sponors equity to purchase the company. I see it as the buyer is using the current cash of the firm to buy it. Can anyone explain how the treatment of excess cash works for LBO deals in the sources of funds section
I buy a box with $100 cash in it with $100 of my own money (equity). I get the box, take out the $100, $0 left.
If a company has a negative net debt position (cash rich), your equity value will be higher than your enterprise value -> ur buying cash $1:$1. Often cash is paid out to shareholders before transaction as it makes no sense borrowing extra (or do a higher capital call from investors) to buy cash. If this isn't done, please do a careful check if the cash isn't trapped somewhere in the business (cash register, third world country with capital restrictions, etc).
This makes sense. Thank you. My next question would be why are LBO models using excess cash as a source of funds. I fully agree with your reasoning that any excess cash should be distributed prior to the transaction and if they don't then the PE can't use the excess cash to buy the company. that is like saying I buy your company with your cash. Can anyone clarify this?
The equity purchase price includes the value of any excess cash. So the sponsor can either (a) pay the full equity purchase price and take the excess cash after the deal, or (b) assume that they have the excess cash to fund the deal. It makes no difference except that (a) results in a lower IIR (unless you assume the buyer pays itself a dividend or something immediately upon closing)
Thank you. option a makes sense but not sure about option b
option a Company A has an EV of 10 and net debt of (5) i.e. 5 in cash and no debt. Equity value is 15. so the buyer needs to pay 15 to the shareholders and gets 5 in cash post-deal. option b PE uses the 5 of excess cash to buy the equity so shareholders are only getting 10. PE only needs to raise 10 to buy equity and post-deal there is no excess cash.
Can you see the difference I am seeing? or am I missing something? Thank you for the help!
No I don’t see any differences between paying $100 for a company with $50 of excess cash vs paying $50 for the same company without any excess cash. This is exactly the same thing.
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