Interview Answer - What Is A Leverage Buy Out (LBO)

a very common investment banking interview question is what is an LBO walking through an LBO model in this video I am going to show you exactly how to answer this question hi I'm NASA I started MSM banking in 2013 and I've recruited and interviewed over a dozen candidates if you're new to this channel then you might want to consider subscribing because every week we release a lot of content on how to break into Investment Banking whether you're looking for interview answers resume templates cover letter templates we cover a lot of stuff which is extremely useful so in essence an LBO is when a private equity firm or a group of private equity firm purchases a company using a large amount of debt whilst only putting down a small amount of their equity a successful LBO will be when a private equity firm buys the company using a large amount of debt but over time have that company pay off the debt so therefore it reduces that the debt level works increases the private equity firms equity amount in that company so 10 years down the line when they go to sell this company they can therefore increase their rate of return because the equity level in this company has increased an easier way to think about an LBO is the movies market if you wanted to buy a house for let's say five hundred thousand dollars but if you were already going to put down $50,000 deposit and then borrow the four hundred fifty thousand for a bank if you rented this property out but then over the span of ten years you use that rent in order to in order to pay down the debt when you go and sell this house because there's no longer any debt on it you own the full amount of the house you can literally recuperate the whole five hundred thousand but remember initially you only put down fifty thousand so this is a huge rate of return and that's essentially what private equity firms do they buy companies using a lot of debt pay down the debt using the company's own cash flow and then down the line private equity firms and LBOs are really important to investment bankers because a lot of investment banking clients are private equity firm especially if you're going to work in the leveraged finance department of an investment bank and this is where you're going to be dealing with a lot of private equity firms so it's really important as a junior investment banker whether you're going to be an analyst or associate or even an intern you are going to get asked questions on private equity how they finance their deals how they value companies it's really important that you know these questions and how to answer them successfully so let's quickly go over a very common interview question which is walk me through an LBO now essentially you do this in six steps step number one here you're going to have to do some analysis as to what price you can offer the owner of the company in order to close the deal so how much do you have to pay the owner of this company in order for them to sell you this company there are two ways you can do this either by looking at an exit multiple so whether they want six times the revenue three times that EBIT four times they're EEB it whatever multiple it may be or you can look at a premium on top of their current share price and using that you can pretty much get a good idea as to how much you have to offer the business owner in order for them to sell you all the equity in this business and then the exit multiple now you can do a quick assumption here of assuming you're going to sell this company on the same multiple as you bought it out step number two sources and uses of capital this is where you're going to be allocating capital blocks to the purchase price the fees for the investment bankers the fees for whoever is involved in this transaction every use of funds you're going to have to allocate here as well as the sources once you've calculated where your fund is going to go so how much it you're going to need to buy this company how much you're going to need to pay in fees etc etc you're then going to need to analyze how and where you're going to be raising this capital so whether you're going to raise a new loan whether you're going to need mezzanine financing etc etc this is one you're going to analyze how and where the money is going to go step 3 perform a balance sheet so once we've made all of our assumptions on the entry and exit price the sources and the use of capital we now need to forecast or create a performer balance sheet of the company that we're going to acquire so that we have a better idea as to whether this company can handle this new amount of debt on its balance sheet does it have enough capital in order to pay off this debt we have to analyze that step number for creating the financial model so once we have created the performer balance sheet we can now begin creating the financial model now I'm not going to go through this step-by-step here you can take a look at the financial modeling course for a step-by-step guidance on how to create with this step 5 is the LBO analysis so once we've created a financial model we now need to analyze the feasibility the profitability and the risk associated with this LBO so we're going to look at the internal rate of return and the multiple on investment finally step 6 we're going to run a sensitivity analysis now this is very important because our model is going to be heavily assumption based and we need to stress test our model so we need to take things in to the extreme and assume that some things are going to go wrong as they always do so even if things go wrong do we still have sufficient cushion to allow us to be profitable in this endeavor if so then we should go forward with it but if our margin of error is so narrow then it might not be worth taking this risk and so a sensitivity analysis will give us an indicator as to how sensitive our model is to our assumptions ok so now that we're done with working through an LBO other common full of question is what is a great LBO candidate what is a bad LBO candidate can you talk to me about a recent LBO deal how might we increase our internal rate of return for - how do sources and use work okay so now I want to talk about who uses this lb your model now essentially there are three parties involved in this you have the buyer which is the P farm you have the seller which is the company and then you have the finances or the investors whether it's a hedge fund whether it's an investment bank now all three of these participants are going to have to make an LP your model and depending on who they are the level of complexity is going to differ so for example if you're the finance here if you're the investor then you're not going to create a 70 or 100 page LBO model with all the bells and whistles because all you care about is whether or not this company or this firm will have the ability to pay interest as well as capital over time because as the investor that's what we care about your way to return but if you're the buyer of this company then you want to know about the capital structure the cost the revenue can you increase the price on per unit of the product that they sell can you cut cost how much does it cost to make one good can we increase this value can we increase the price of this you want to make a highly detailed LBO model with every Bell and whistle so the level of complexity on the buyer side is going to be very different from the financier side likewise from the set aside the seller has incentive to maximize the price which they can get for this company whereas the buyer has incentive to minimize the price so they're they're literally fighting at odds with each other and they're going to have to negotiate on the price and because of that they're going to use a lot of complicated financial metrics and a lot of financial engineering that's going to go into making this deal work okay as usual if you have any questions on LBO investment banking or this interviews of your modeling please leave it in the comment section below I'll try to answer it there if I don't then I'll answer it in the next video otherwise all of the Investment Banking interview questions and answers are in the interview guide and if you'd like to know however some bankers do they'll be analysis then check out our Anderson banking training course

Channel: High Finance Graduate

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Keywords: leveraged buyout, what is an lbo, private equity, leveraged buyout model, lbo, lbo questions and answer, walk me through an lbo, corporate finance, mergers, acquisitions, internal rate of return, lbo model, simple lbo model, leveraged buyouts

Id: vi2j7ups6Is

Length: 8min 57sec (537 seconds)

Published: Tue Jan 22 2019