Investment professionals both in private equity and in investment banking should not only understand the basics but also master an LBO aka Leveraged Buyout model. As investment professionals, you would come across the term Leverage Buyout numerous times whether as an LBO model or as a transaction. Thus mastering the aspects of an LBO model is a must for private equity investment professionals.
What is an LBO model?
To understand the basics of an LBO model, let’s first understand what is it. An LBO or a leveraged buyout refers to the acquisition of another organization utilizing a significant amount of borrowed money to meet the acquisition cost. In an LBO transaction, the assets of the organization that is being acquired are often used as collateral for the loans, along with the assets of the organization that is acquiring the other company.
Private Equity Firms and the Importance of an LBO Model!
Built-in Excel, an LBO model evaluates a leveraged buyout transaction with an aim to enable investors to assess the transaction properly and thus earn the highest possible risk-adjusted internal rate of return (IRR).
All said and done, let’s understand why is important for private equity investment professionals to have a thorough knowledge of an LBO model.
Private Equity firms in Austin TX, seek candidates who have shown a proven track record of being self-motivated, self-learned, and quick-learners. But why do you need to know about an LBO model? Right?
Understand this, Private Equity firms during the interview would ask to build an LBO model and this could be at various stages of the interview process. So if you wish to crack an interview at one of the best Private Equity firms then you should be well-prepared and should be able to complete any variation of an LBO model prior to your interview.
As already discussed a leveraged buyout is the acquisition of a public or a private organization with a significant amount of borrowed funds, we would discuss how US private equity firms use an LBO model.
Top Private Equity firms acquire an organization using the debt mechanism as the majority of the purchase price. Once the company is purchased, the debt or equity ratio is usually greater than 1.0x – which means that debt usually constitutes 50-80% of the purchase price. Now understand this – during the organization’s ownership the cash flow is used to service and pay down the outstanding debt.
If you wish to make a success of your Private Equity Career, then you need to master an LBO model because buyouts are one of the core functions of private equity firms. And if you wish to crack your private equity interview then you should be able to build an LBO model both from scratch or complete the missing links in the preexisting table.
Private Equity investment professionals would be a given an LBO model sample during their interview, which could be used to test on various issues like –
• Determination of a fair valuation of an organization that would also include its ability-to-pay analysis
• Determination of the equity returns through IRR calculations, which could be achieved if an organization has taken is private, grown, and in the end, sold or again acquired as public
• You would also have to determine the effect of recapitalizing the organization through the debt issuance in order to replace equity.
If you plan to have a career in private equity, then mastering an LBO model is a must for you. Of course, Private Equity Certifications from reputed credentialing bodies like the United States Private Equity Council aka USPEC is a great way to boost your career.