Leveraged Buyout Model

A leveraged buyout model gives you an idea on what will happen when a private equity firm acquires a company, whether it’s a combination of equity (cash) and debt, and then sells it after a certain time period say, in 3-5 years. Normally Private Equity firm targets a return of 20 – 25% margin by doing this. Leveraged buyouts are somewhat related to normal M&A deals, but in an LBO model, there is a high probability that the buyer would sell the target in the future.

How does LBO works?

By a simple example let’s look at how a leverage Buyout Model Works?  An LBO can be simply co-related to the procedure of buying a house using a combination of down payment and balance through a mortgage loan. In both the house buying and LBO Model, you save certain money by putting down a small amount in cash and then borrowing the rest.

Similarly in an LBO, the “down payment” can be called as Equity (cash) and the “mortgage loan” as Debt. The PE firm uses debt to boost its returns. Below given are the 8 steps involved in an LBO model;

1. Determine the purchase price and the amount of debt and equity required.
2. Allocate percentage totals, repayment percentages, and interest rates, to the debt tranches.
3. Create a source & uses a table to track how funds are used in the deal.
4. Build Income Statement projections based on assumptions for revenue and expenses.
5. Calculate the free cash flow and the cash available for debt repayment.
6. Complete the debt schedule and regulate the mandatory and optional repayments.
7. Link the debt schedule to the cash flow statement and income statement.
8. Calculate investor returns and create sensitivity tables.

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