The buyout builder is a simple and illustrative calculator/model that takes in a few high level parameters of a business and tries to solve for the lowest possible amount of equity required to fund an acquisition. The key inputs of the target company required are:
Sales: Current year and next year's sales, including the expected growth in sales going forward
EBITDA margin of the business: A measure of cash flow and assumes that this does not change over the forecast period
Cash: The amount of idle cash in the target company's bank that can be used towards repaying existing lenders in a buyout scenario
Fixed assets: The level of operating fixed assets such as plant, property & machinery in the business. Does not include cash
Current bank debt: Amount of borrowings currently owed by the company
Net working capital: Defined as operating current assets - operating current liabilities. If you don't know this number, the default based on the industry average will be used.
Be sure to read the limitations on using this spreadsheet below too.
What are the limitations?
Capital expenditures are driven based on the average industry sub-sector. It is driven based on a percentage of sales.
The book of equity is an implied number here based on your inputs on fixed assets, cash, bank debt and working capital. Simplify and calibrate the balance sheet numbers accordingly if you wish to use exact numbers.
There is an option of NOT repaying the existing debt. The model ignores any interest accrued and principal repayments from this. For the best results, always set this to repay all outstanding debt.
The debt sizing algorithm
The repayment schedule is configured as a "sweep" i.e. it is automatically sized based on:
Loan Tenor which is loosely implied from the Debt/EBITDA multiple. A higher multiple translates to longer tenor and hence, higher debt amount
DSCR (Debt Service Coverage Ratio) - which drives the CFADS (Cash Flow Available for Debt Service) in the model.
Interest rate. The higher the interest, the lower the amount of acquisition debt
Garbage in = garbage out.
The dynamics in every buyout deal is different. Every financial model has its limitations. This spreadsheet does not seek to solve all of these factors but rather to illustrate flow of thought and produce a "quick and dirty" solution to understanding the indicative funds required for the transaction that you are looking at.
(Can't view? Try this alternate page: https://www.kennyng.com/lbo-builder)
Many people get caught up in the term LBO (Leveraged Buy Out) when it comes to modelling.
An LBO is nothing more than a buyout of a business that is heavily funded by debt, usually 65% or more. In contrast to traditional LBO deals in the US, the concept and structure of harnessing leverage in Asia are relatively simpler, sometimes involving a couple of debt tranches.
From a capital budgeting point of view, most buyers will seek to use debt funding as it is less costly than using (or raising) equity, but more importantly, financing an acquisition using more debt means that the amount of cash outlay can potentially be lower i.e. enhancing the returns to equity.
Cash flows are critical.
The choice and structure of debt funding used in an acquisition is largely predicated on the nature and quality of underlying cash flows. This is the most critical and fundamental aspect of all LBOs.
Ultimately, the increase in equity value from a buyout comes down to essentially three factors:
Consider this illustrative scenario:
A company valued at 6.0x EBITDA at the point of acquisition based on a $100m EBITDA results in a deal value of $600m. Assuming the buyout was financed with 80% debt, the corresponding value of equity is $120m.
Upon exit, let's assume that the EBITDA has grown by 20% to $120 and the company is valued higher at 7.0x, the resulting EV would be $840m. Because part of the acquisition debt has been repaid over the investment period, the net debt on exit has been reduced to 30% or $252m, giving an exit equity value of $588m.
From the above, we can easily observe that we have increased the value of equity from $120m to $588m, which translates to a nearly 5-fold return. To break this down, let's first look at EBITDA. The value we've created here from improving the operating cash profits can be quantified as:
Secondly, in the process of driving the top and bottom-lines i.e. size and profitability, the financial sponsors have also changed the overall "risk profile" of the business, such as: expanding to new markets, developing proprietary technology in new products, institutionalizing sales processes and improving the overall quality of customers, etc. These enhancement initiatives make the business better, or what bankers commonly call: equity positioning or equity re-rating. The idea behind this is to re-position the company more favourably amongst its competitors so as to justify a valuation multiple premium. In this case, we had assumed that on exit, the company will be valued at 7.0x EBITDA. The uplift in equity based on this can be calculated as:
Lastly, it's the additional value created from financial engineering. This is nothing more than just the reduction in net debt of the company from entry to exit. The value created is simply the difference between the net debt amounts:
Putting it all together, we have:
We have therefore effectively quantified the three sources of value creation to be a total of $468m. Although deleveraging drives most the value here, collectively, both improvements to the EBITDA and re-rating of the business post investment is also significant.
Feel free to play around with the parameters using the below spreadsheet: