Lbo Case Study

The financing structure of a LBO transaction varies depending on:

Specific characteristics of the target company, mainly its operating model and its current financial structure of the balance sheet before the transaction. Factors such as the market in which the company operates, its history of performance, the seasonality of its business, its markets position, the stage of the lifetime cycle in which the company is, its growth rate and the stability of its business will determine the suitability to be the target of an LBO transaction and the structure of the same.

Market conditions, which relates to the financial instruments available to structure the transaction and how their respective markets operate in the moment in which the transaction

Since it has the higher propriety of claims it has the lower risk and therefore is granted at very reasonable prices in terms of interest rates. Nevertheless, banks will usually require this tranche of debt to be guaranteed by the assets in place at the time of the transaction, mainly fixed assets such as Property, plant and equipment, but also receivables, inventories and even intangible assets such as patents and/or trademarks. Therefore, this financing will be designed depending on each specific transaction. It is usually prices at euribor/libor + 0,5% approximately and the amount granted is in the range of 3 times EBITDA. It has normally a maturity in the range of five to seven years. Its cost is in the range of 7%-10%. The payback of this financing can be composed of periodic interest and capital payments or periodic interest only payments and capital repayment at the end of the loan term.

MEZZANINE DEBT: it has the particular characteristic, as opposed to senior debt, that interest rates payable can be paid in cash at due time or rolled out and paid in full at the end of the term of the debt. It is placed in the middle of the financing structures in terms of priority of claims. It is obtained either in the public market, or given by insurance companies or mezzanine funds in private placements. Its maturity is in the range of seven to ten years, and its cost

It is important not to force management to tie too much of their wealth in the LBO target, because they could become too risk averse, but at the same time guarantee they are incentivized to succeed in their role and that their incentives are aligned with those of the fund participants. Sometimes management already own equity in the target company and therefore they only have to roll over their equity into the new entity. The objective of this is to guarantee the alignment of company managers and the shareholders (fund subscribers).

PE funds, in order to reduce their exposure to a single investment, usually limit their participation in the equity of a company to a maximum of 70%. As another way to reduce risks, especially for large transactions, they create syndicates of various PE firms to share the risk and diversify the allocation of funds.

This list is ordered according to the priority of claims of the different instruments, meaning that senior debt has the highest priority of claim in case of bankruptcy or liquidation of the company, whereas equity has the lowest priority and, in case of bankruptcy, the highest risk of no recovery of capital