Private equity and M&A
LBO model. Hieu Van Nguyen
A leveraged buyout buys a company mostly with debt and repays that debt from its cash flow. This build uses an invented company. Change the price, the debt, the growth and the exit, and see the return, the debt paydown and whether the credit statistics stay healthy.
What this shows
Sources and uses of funds at close
Debt tranches with required payments, interest and an optional cash sweep
Returns by exit year with a sensitivity grid
Credit statistics such as leverage and interest cover through the hold
Sample build: LBO of an invented company
Brookmere Services is an invented business being bought with a mix of debt and equity. The build sets out sources and uses, repays debt from cash flow with an optional sweep, and shows the return to the equity investor and whether the credit statistics stay healthy.
Synthetic inputs for illustration. Not data from any employer.
What to try
- Raise total debt on the Deal tab and watch the return climb while the credit panel gets worse. More debt lifts the return and cuts the margin for error.
- Set the cash sweep to zero on the Deal tab. Cash piles up and the term loan stays put, so the return falls a little.
- On the Returns tab, move the exit year between 3 and 7 and compare the yearly return with the multiple of equity.
- Set the senior notes to be repaid in year 4 on the Deal tab, then read the debt schedule to see what a maturity inside the hold does to cash.
The starting inputs.
Yearly return
17.9%
Exit in year 5 at 10.0x
Multiple of equity
2.28x
Equity out over equity in
Equity invested
$545M
52% of the funding
Equity value at exit
$1,242M
Net debt $274M
Does the credit hold up?
Holds up
No limit is crossed in any year of the hold.
Debt peaks at 5.0x EBITDA. The lowest interest cover is 2.48x and the lowest fixed charge cover is 1.23x.
Limits used here: total debt at most 6.0x EBITDA, interest cover at least 2.0x, fixed charge cover at least 1.2x. A stated limit, not a real lender's term.
Interest is charged on each tranche's opening balance for the year. That is a simplification that keeps the maths from going in circles. The revolver is a credit line the company draws when cash runs short and repays first when cash allows.
Sources and uses at close
Sources are where the money comes from. Uses are what it pays for. They must be equal, and the sponsor equity is whatever the debt does not cover.
| Source | $M | Share | x EBITDA |
|---|---|---|---|
| Revolving credit line (undrawn at close) | 0.0 | 0.0% | 0.00x |
| Term loan | 300.0 | 28.7% | 3.00x |
| Senior notes | 200.0 | 19.1% | 2.00x |
| Sponsor equity | 545.0 | 52.2% | 5.45x |
| Total sources | 1,045.0 | 100.0% | 10.45x |
| Use | $M | Share | x EBITDA |
|---|---|---|---|
| Purchase of the company | 1,000.0 | 95.7% | 10.00x |
| Fees | 25.0 | 2.4% | 0.25x |
| Cash left on the balance sheet | 20.0 | 1.9% | 0.20x |
| Total uses | 1,045.0 | 100.0% | 10.45x |
Sources less uses is 0.0. Sponsor equity is 52% of the funding and debt is 48%. The thinner the equity cushion, the smaller the fall in value that wipes out the owners.
Does the arithmetic tie?
All 15 integrity checks pass.
Show the 15 checks
- PassSources equal uses at close
- PassUses add up to price, fees and cash
- PassDebt tranches add up to total debt
- PassRevolver rolls forward each year
- PassTerm loan rolls forward each year
- PassSenior notes roll forward each year
- PassCash rolls forward each year
- PassEach year opens where the last one closed
- PassOpening balances in year 1 are the balances at close
- PassNo debt balance is negative
- PassCash flow after debt service is before debt service less interest and repayments
- PassTotal debt and net debt add up from the tranches
- PassEquity value at exit is exit enterprise value less net debt
- PassValue bridge adds up to the gain in equity
- PassYearly return compounds to the multiple of equity
Cash flow, before and after debt service
Debt service means interest plus the repayments the lenders require. Cash flow before debt service is what the business produces. Cash flow after it is what is left to repay more debt or keep. Tax is charged on EBITDA less depreciation and amortization less interest, which is why more debt lowers the tax bill. Growth and margin move in a straight line to year 5 and then hold.
| $ millions | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
|---|---|---|---|---|---|
| Revenue | 662.5 | 698.9 | 733.9 | 766.9 | 797.6 |
| Revenue growth | 6.0% | 5.5% | 5.0% | 4.5% | 4.0% |
| EBITDA | 109.3 | 119.7 | 130.3 | 140.9 | 151.5 |
| EBITDA margin | 16.5% | 17.1% | 17.8% | 18.4% | 19.0% |
| Memo: depreciation and amortization | 23.2 | 24.5 | 25.7 | 26.8 | 27.9 |
| Less: cash tax | -10.5 | -13.2 | -16.0 | -18.9 | -22.0 |
| Less: capital spending | -26.5 | -28.0 | -29.4 | -30.7 | -31.9 |
| Less: working capital | -3.8 | -3.6 | -3.5 | -3.3 | -3.1 |
| Cash flow before debt service | 68.5 | 74.9 | 81.4 | 88.0 | 94.6 |
| Less: interest | -44.0 | -42.4 | -40.5 | -38.3 | -35.7 |
| Less: required repayments | -15.0 | -15.0 | -15.0 | -15.0 | -15.0 |
| Cash flow after debt service | 9.5 | 17.5 | 25.9 | 34.7 | 43.9 |
Debt schedule with the cash sweep
Each year the cash left after required payments first repays any credit line draw. Then the sweep share of what is left prepays the term loan, and the remainder builds cash. If cash flow is negative the revolver is drawn to keep cash at the minimum. Interest uses the opening balance of each tranche.
| $ millions | Close | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
|---|---|---|---|---|---|---|
| Interest: revolver | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | |
| Interest: term loan | 24.0 | 22.4 | 20.5 | 18.3 | 15.7 | |
| Interest: senior notes | 20.0 | 20.0 | 20.0 | 20.0 | 20.0 | |
| Revolver drawn | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | |
| Revolver repaid | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | |
| Revolver balance | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 |
| Term loan, required repayment | -15.0 | -15.0 | -15.0 | -15.0 | -15.0 | |
| Term loan, cash sweep | -4.8 | -8.7 | -12.9 | -17.4 | -21.9 | |
| Term loan balance | 300.0 | 280.2 | 256.5 | 228.6 | 196.2 | 159.3 |
| Senior notes repaid at maturity | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | |
| Senior notes balance | 200.0 | 200.0 | 200.0 | 200.0 | 200.0 | 200.0 |
| Cash | 20.0 | 24.8 | 33.5 | 46.4 | 63.8 | 85.7 |
| Total debt | 500.0 | 480.2 | 456.5 | 428.6 | 396.2 | 359.3 |
| Net debt | 480.0 | 455.5 | 423.0 | 382.1 | 332.4 | 273.5 |
The chart plots the balance rows of the table above. The term loan is the only tranche the sweep reduces. The notes stay until they mature, so a sweep does nothing for them.
Credit statistics
Leverage is debt over EBITDA. Interest cover is EBITDA over interest. Fixed charge cover is EBITDA less capital spending and cash tax, over interest plus the required term loan repayments. A star marks a reading that crosses its limit. The notes repayment at maturity is tested as cash short of the minimum rather than inside fixed charge cover.
| Measure | Close | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Limit |
|---|---|---|---|---|---|---|---|
| Total debt over EBITDA | 5.00x | 4.39x | 3.81x | 3.29x | 2.81x | 2.37x | at most 6.0x |
| Net debt over EBITDA | 4.80x | 4.17x | 3.53x | 2.93x | 2.36x | 1.80x | no limit |
| Interest cover, EBITDA over interest | 2.48x | 2.82x | 3.21x | 3.68x | 4.25x | at least 2.0x | |
| Fixed charge cover | 1.23x | 1.37x | 1.53x | 1.71x | 1.93x | at least 1.2x | |
| Cash short of the minimum | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | none |
Yearly return
17.9%
Over 5 years
Multiple of equity
2.28x
$545M in, $1,242M out
Equity value at exit
$1,242M
Enterprise value $1,515M
From exit price to equity
| Line | Amount |
|---|---|
| EBITDA in year 5 | 151.5 |
| Exit multiple | 10.0x |
| Enterprise value at exit | $1,515.4M |
| Less: net debt at exit, debt less cash | -$273.5M |
| Equity value at exit | $1,241.9M |
| Equity invested at close | $545.0M |
| Multiple of equity | 2.28x |
| Yearly return | 17.9% |
The sponsor receives nothing until the sale. The yearly return is the multiple of equity compounded back over the years held.
Where the return comes from
| Step | Amount | Share of gain |
|---|---|---|
| Equity invested at close | $545.0M | |
| EBITDA growth, valued at the price paid | +$515.4M | +74% |
| Change in the multiple, on exit EBITDA | $0.0M | 0% |
| Debt paid down and cash built | +$206.5M | +30% |
| Fees paid at close | -$25.0M | -4% |
| Equity value at exit | $1,241.9M |
Reading the bridge
Returns by exit year
The debt schedule does not change with the exit year, so each row below uses the same cash flows. Click a year to make it the exit.
| Exit year | EBITDA | Net debt | Equity value | Multiple | Return |
|---|---|---|---|---|---|
| 130.3 | 382.1 | 920.5 | 1.69x | 19.1% | |
| 140.9 | 332.4 | 1,076.8 | 1.98x | 18.6% | |
| 151.5 | 273.5 | 1,241.9 | 2.28x | 17.9% | |
| 157.6 | 209.0 | 1,367.0 | 2.51x | 16.6% | |
| 163.9 | 138.5 | 1,500.6 | 2.75x | 15.6% |
A later exit gives more time to repay debt and usually a larger multiple of equity. The yearly return can still fall, because each extra year adds less than the one before.
Sensitivity: what moves the return
Each cell reruns the whole deal, including the debt schedule, with a different pair of assumptions. Everything else stays where you set it. The outlined cell is the current deal, held for 5 years. Debt is set as turns of EBITDA, so a higher price means more equity, not more debt.
| Price paid | 8.0x | 9.0x | 10.0x | 11.0x | 12.0x |
|---|---|---|---|---|---|
| 9.0x | 16.2% | 19.8% | 22.9% | 25.8% | 28.4% |
| 9.5x | 13.7% | 17.2% | 20.3% | 23.1% | 25.6% |
| 10.0x | 11.5% | 14.9% | 17.9% | 20.7% | 23.2% |
| 10.5x | 9.5% | 12.8% | 15.8% | 18.5% | 21.0% |
| 11.0x | 7.7% | 11.0% | 13.9% | 16.6% | 19.0% |
| Debt at close | 8.0x | 9.0x | 10.0x | 11.0x | 12.0x |
|---|---|---|---|---|---|
| 4.00x | 10.7% | 13.7% | 16.4% | 18.8% | 21.1% |
| 4.50x | 11.1% | 14.2% | 17.1% | 19.7% | 22.1% |
| 5.00x | 11.5% | 14.9% | 17.9% | 20.7% | 23.2% |
| 5.50x | 12.0% | 15.6% | 18.9% | 21.8% | 24.5% |
| 6.00x | 12.6% | 16.5% | 20.0% | 23.1% | 26.0% |
Reading the grids
Selling one turn higher gives 20.7% a year instead of 17.9%. Paying half a turn more gives 15.8%. Half a turn less debt gives 17.1% and half a turn more gives 18.9%.
More debt lifts the return only while the business earns more than the debt costs. The credit check above shows what that extra return costs in safety. The debt grid does not stop at the limit lenders would accept.
Buying at 10.0x EBITDA with 5.0x of debt and selling at 10.0x after 5 years returns 17.9% a year and 2.28x the equity invested. The credit holds up.
How I use it
Testing how much debt a business can carry before the returns depend on it
Showing a seller what price still works for a buyer
Explaining which lever matters most: price, leverage, growth or the exit