How to do a Paper LBO (MUST Know for Private Equity)
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- Опубліковано 20 тра 2024
- 💡 Get the #1 Private Equity recruiting course, which comes with 3-statement LBO model tests, mega fund case studies, and headhunter coverage: bit.ly/PF-PrivateEquity
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The Paper LBO is one of the most important technical questions in private equity interviews. The Paper LBO combines corporate finance, investing concepts and mental math, making it an effective test for interview candidates. In this video, we'll break down what an LBO is, the steps to build one, and how to compute one using just a pen and paper. With practice, you should be able to build a paper LBO within 5-10 minutes.
** Full Blog Post: www.peakframeworks.com/post/p...
0:00 - How to Build a Paper LBO
4:08 - Paper LBO Question
5:11 - Paper LBO Answer
Peak Frameworks is a business career prep service started by Matt Ting and Patrick Fong, who have each spent several years working in investment banking and private equity in New York and Silicon Valley. Matt and Patrick met at Evercore, a top tier investment bank, and over the years have tutored and coached dozens of candidates to land their dream business job.
Matt Ting: / matthewting
Patrick Fong (HBS 2021): / patrick-fong-0b773041
#PrivateEquity #LBO #PaperLBO
man needs to drop his skin care routine asap
Stiev-A (Tretinoin) x 1 per day, Cetaphil cleanser and moisturizer x 2 per day. Then drink like 10 glasses of water
get you a man who uses retinol✨
Great job on video editing here. Adding the transparency was a nice touch. Most would simply take the video completely off when building up the spreadsheet, but I like this touch more.
Very helpful and useful video, thanks so much! Would be awesome to make more 'paper' technical qs videos such as paper DCF, merger model, valuation, etc
Well structured video, explaining the LBO model in an easy to follow and informative way! Well done!👌👏
"Rule of 72" gives you the approximate CAGR for a *doubling* (i.e., 2x) of your initial investment when you know the investment horizon (in years). In your example, the initial equity was doubled (~1.9x) at exit, that's why the heuristic worked.
Excellent video. Keep it up.
Yeah that's what made no sense to me, he went through the trouble of building a whole model, projecting future EBITDA and getting an Exit value, only to calculate IRR by using 72/3. Really don't think he should be teaching this method so confidently and thank you for clarifying
@@TheMigider, just relax. He has the credentials to be teaching this stuff. It was just a minor oversight.
@@likkledee3 True, was a bit harsh, but the way he explained it, basically means any investment ever that has 3 years investment period will have 24% IRR, would've been good if he clarified a bit.
This is all fair, I'll post a follow-up video fully explaining Rule of 72!
Just to see If I understood you correctly, every time there is a MoM of 2.0x, the 72 rule will work?
Super helpful and straightforward, thanks man!
This is too good Matt, thank you
I love your videos man. I should’ve watched this before my Blackstone superdays 😂
Amazing, thanks man!
Extremely helpful. Can't thank enough!
Hey, great video. Got a questions for you, how does a company of individual qualify for LBO financing?
Well done!! Thanks
Why do you calculate the levered free cashflow instead of the unlevered free cashflow? Thanks
!
Well done!! Thanks. Nice video! Thank you :).
Great video!
sorry minor point but in your D&A assumptions you said its 10%, but in your calculation did you not take 20%? Is there something that I'm not getting or is this a mistake?
Thanks btw great video!
Very helpful thanks
I work in real estate and will never work in traditional IB or PE. I Didn't major in finance and a lot of the terms here are different than we use in real estate but at the end of the day we are doing the same thing. Your videos have been helpful in me being able to understand more of what my friends do in PE and IB.
in my financial model training at an investment bank, we did RE return models haha
Real estate agents; The real scum of the society, How does it feel to be a scum bag in 2022?
Nice video! Thank you :)
Amazing video. Quick question, in a case were you have to forecast the balance sheet, you should be given the debt amortization schedule, instead of paying out all the debt in the exit of the investment?
The most common alternative is that you'd use the excess cash flow each year to pay down the debt (i.e. the $20mm then $25mm then $30mm). Said otherwise, you just assume that you can use all cash flow for optional debt repayment.
Paying down debt would also reduce the interest expense the following year, so the answer would be slightly different.
In real life, is the leveraged buyout simple interest like in the example?
When trying to assess whether a firm can pay off in time its loans, is it safe to assume that EBITDA is a good gauge to meet interest expense, and free cash flow (or maybe EBT) will be used to calculate the loan principal outstanding? are there other workarounds, or metrics that you'd look at to see if the business can meet its loan obligations?
Most lenders actually just model it out to see the cash flow profile. EBITDA is generally a fine gauge. You might look at EBITDA / Interest to see the coverage ratio. Also debt and net debt / EBITDA.
Thanks for the video. Couple of comments:
1. You mention "assume all debt is paid down upon exit" in your question statement, but that's not the case since we don't have enough cumulative FCF to pay down all debt.
2. I would also assume a beginning balance for your FCF in 2021 which comes out to $15MM per the boundary conditions stated in the question. So, your cumulative FCF should be $90MM instead of $75MM.
Thanks!
1. I'm not assuming that 100% of debt is paid down upon exit. That assumption is just saying to make any payments on debt only at exit. This is to prevent people from paying down debt on an annual basis and complicating the mental math of interest expense. You can see at 10:41 that only the cumulative cash flow of $75mm is used to pay down debt (and that it all happens upon exit).
2. The transaction occurs at the end of 2021, so I don't think it's reasonable for us to assume we will get that $15mm of FCF. I think it's fairer to assume the prior owner of the company would get the FCF since it was generated over the course of 2021.
Maybe I'm wrong but doesnt the interest rate you include in your calculations (considering your 21 FCF of 15MM) don't apply for the first year (2021)? I mean that would mean you took out a loan at the end of 2021 and paid interest for months not even included in the loan period. W/o that debt interest the 2021's FCF comes out to 40MM instead of the 15MM sum you mentioned.
The rule of 72 isnt conciderate of moic so how is it a useful metric? If my moic in a paper LBO is 3 or 4 then my IRR wouldnt fit the parameters of that rule of thumb. How do i approximate it on paper in this case?
Why isnt the debt paid down year by year as possible allowing less interest to be paid each year? Confused on why the interest paid stays constant yoy.
Great video! Paper LBOs are useful in an initial underwriting. We calculate IRR differently. Does this method account for the time value of money? Or is it calculating the CAGR as @likkledee3 said?
Mans doesn't take any Christmas breaks 😤
Business never sleeps
😤😤😤
thank you for good video, just i am wodering that is not it to calculate for FCFF? if so, i think the cash flow logic is not considered interest cost. i mean the formula is EBIT(1-t) + dep -capex +- networking capital movement. 09:58 slide already consider debtor's cash out. so i think it is not a FCFF.
For LBOs, we should use FCFE. LBOs examine the returns to the equity investor, so we should be using FCFE. Therefore we need to deduct interest expense and ultimately deduct the debt balance.
Great vid as usual! Can you go over Paper DCFs in a vid?
No body does paper DCFs..
Paper DCFs aren't really a thing because it's a lot harder to calculate the time value of money factor in your head, which is needed for DCFs. IB interviews tend to focus on accretion dilution and flow throughs for the "technical" questions. Maybe I'll do a video just so people know how to do it conceptually though!
Hey Matt! Thank you so much for the video. I have a question about breaking into IB: I'm a high school senior, and I have the opportunity of
a) Doing my freshman year at UGA, and I have a guaranteed offer at the Atlanta fed as a paid summer internship, or
b) Going to a semi-target (Vandy / Emory).
Which would you think is the better choice?
I would personally go to a semi-target. Both Emory and Vandy place well. I think it'll improve your overall chances of getting a better job out of school.
Atlanta fed seems like a cool role, but it's not enough of a landing board to automatically get a great job. I think going to UGA increases the chances you stay in Atlanta significantly.
@@PeakFrameworks thanks
@@glebalikhver1385 if u are already learning paper lbo's in high school, then you will prob land IB regardless, and ik many freshmen struggle to get internships their first summer, so one at the fed would help you really stand out. He is right that you will prob have slightly easier time recruiting with Vandy, but i wouldnt make my college decision based on that if I were you.
Since you will prob land IB regardless, I would go with the college you actually like more and think you will have a better time at, which may be a big college like UGA, but I personally do not like college towns so it is really depends on the person.
Good luck and enjoy college!
@@habibbialikafe339 thank you! Late but thankd
The frames on the wall are not aligned. It bothers me.
I noticed you used levered free cash flow. Do you always used levered free cash flow in an LBO compared to UFCF in something like a DCF?
Yes, because we're concerned with the return to equity investors for IRR. We need to deduct interest and debt payments to see what we get as shareholders. You are correct that you should use UFCF for a DCF though because that looks at overall company value.
Capex is a before-tax event. In this case it would be included in the tax calculation resulting in a lower tax. You then add back D&A to arrive at a higher free cash flow. no?
Nope, capex is after tax. On the cash flow statement.
LOL, this PE firm is seeking 'Alpha'!!!!
Matt, great run down of the basics. It is nice to see this applies to Real Estate Private Equity as well as Big PE firms. I am starting to move into the former and avoiding the latter. But this info and your courses are still relevant and helpful.
Hey Matt, I was on a call with an analyst from BGL a few days ago to connect with him and he mentioned a type of model called “precedents” that have something to do with a company/firms transaction history. I was wondering if you had made a vid on this, and if not, if you would consider it.
It's in our Valuation course, but I can add it to the list of things to do too.
Sounds great! Thank you for consistently making very informative videos and being open and willing to viewer suggestion!
There are three valuation methods that you need to know for banking: discounted cash flow, precedent transactions, and comparable companies.
I haven't studied this technically yet, but from the top of my head it just means you value a company's implied (should-be) equity value based on how other similar companies sold via buying out the equity value.
Example would be if you were valuing a McDonalds in the area, you would look at how much another similar-revenue fast food chain sold for.
what do you use to edit your videos? Or do you just outsource it?
I used to use Premiere Pro, but now I outsource it (my editor also uses Premiere Pro though).
Thoughts on working for a family private equity office straight ouf of school?
I'd probably take IB over it personally just to retain optionality. It's really hard to assess smaller buyside firms out of school. So if it ends up being a bad training ground or performing poorly, you won't be able to pivot as well. Altogether it's still a great seat though
Hey Matt, thank you for this very useful video. What are your thoughts about joining secondary PE out of undergrad.
** For context, I’ve done IB Internships and now deciding between accepting an IB or a Secondary PE job offer. **
Thank you very much!!
I would personally take IB offer. You can get secondary PE after IB if you still want it. But you won't be able to go to HF / PE if you go straight into secondary. Secondary is a cool space, but it's a bit too new to know how good its exits are.
🎯 Key Takeaways for quick navigation:
00:00 📊 *Paper LBO Overview*
- The paper LBO is commonly used in private equity interviews to test key LBO mechanics.
- It assesses your ability to work with simple financial data and perform calculations on paper.
- The steps in a paper LBO include determining transaction assumptions, forecasting financials, and calculating debt paydown and returns.
03:48 💰 *Calculating Purchase Price and Debt*
- To calculate the purchase price, multiply the purchase multiple by the company's revenue and debt.
- Debt and equity financing are essential in an LBO; you need to know how much of each is used.
07:14 📈 *Forecasting Financials*
- Create a forecasted income statement, focusing on key items like revenue, EBITDA, and deductions for interest, DNA, and taxes.
- Calculate free cash flow, which is crucial for debt paydown and returns analysis.
10:19 💳 *Debt Paydown and Returns*
- Debt paydown is the cumulative free cash flow generated to pay down debt.
- Calculate the exit enterprise value to determine the sale price and use it to compute investment metrics like multiple on money (MOM) and internal rate of return (IRR).
Do you think lbos are important for growth equity interviews?
If it's late stage growth equity, then yes it's pretty much the same. Growth equity models are just LBOs with less debt. You probably won't have to do a paper LBO though, but you may as well learn it.
Why do you assume a 50% EBITDA margin? It wasn't given in the question, does this mean we'll have to arbitrarily come up with an EBITDA margin during a paper LBO test?
The EBITDA margin assumption of 50% is stated at 4:30 in the video.
@@PeakFrameworks Got it! Missed out on it somehow. Thanks!
Hey was curious about your FCF calculation. Realised you used an FCFE method; since there were no new borrowings, it makes sense to assume that they were 0. However, if that was the case, then shouldn't interest rate be subtracted out to attain FCFE? Also, I utilised an FCFF method, attaining 45, 50 and 55 for years 1-3 respectively. Hope you could clarify if there was something wrong in my approach.
Interest rate is deducted ($500mm x 10% rate = $50mm per year). The prompt states to not pay down debt during the forecast to make it easier, so it is paid down all at the end. I'm not sure how you got to those numbers, but you may be deducting tax if they are that high? You can check the completed financial statement at 10:34 to see where you might've calculated differently.
@@PeakFrameworks Similar question, why was levered fcf used instead of unlevered fcf in this lbo? I used EBIAT for my calculation not net income so that threw me off. Kind of lost at this part.
For an LBO, we need to make sure to deduct interest expense because it impacts how much cash we have at the end to pay down debt. We're focused on getting to IRR and MoM for the equity holders, so we should be looking at levered FCF.
For a DCF, you use unlevered FCF and wouldn't deduct interest expense. This is different.
@@PeakFrameworks that makes a lot of sense Thanks!!!
No.honit
Nimena.
In a real interview, is it going to be that simple?
Yes, potentially even easier
whats dna
Depreciation and amortization
@@keyaanmithani9497 oh lol duhhhh.l.
Serious question.
I started learning about fundamental analysis about 2 years ago and I live and breathe business now. I actually pretty well solved this, first time ever no practice, using just the numbers given without following the video. Not a brag but I understand business and every financial statement there is at a deep level after making my own DCF’s, running my own real estate business which you’re right is realistically the exact same model, and reading hundreds of annual reports.
Investing is what I want to do for a living but I learned too late while in medical school. Why is getting into finance such a damn structured process? They miss out on talent that didn’t know more or weren’t exposed to this world in high school/undergrad.
What is the best bet for people who realized too late but want to work in this world? I feel hopeless like no matter how much I know I won’t break in as supposedly even MBA without IB experience is a lost cause.
Well you should know that it's definitely still possible - my IB class had a doctor in it who had no prior business background. I would lean into being a healthcare specialist and start networking aggressively with IBs if you haven't already. It's not just about the technical knowledge, you have to build a pattern of extra-curriculars like investment club, stock pitches, etc. that show that you're committed to the career.
@@PeakFrameworks I appreciate the reply, thank you. I have a few 2-page stock pitches so potential employers can get some insight into how I analyze stocks.
I always keep up with your videos, you do such a great job.
You might want to look into the CFA. CFA can help get your foot in the door for asset management. Passing at least CFA level 1 could give you an edge and show potential employers you're serious about finance as a career
@@cameronwoods7891 I appreciate that. You think that would better help me than the GMAT followed by an MBA at a T15-M7?
@@andersonfuller yeah so I'd say really that all depends on your future goals and ability to take on additional grad debt probably. The CFA is much cheaper than an MBA but doesn't give you the alumni/connections of an MBA. CFA focuses narrowly on finance while MBA is much more broad business focus. If you're serious about landing an equity research job then CFA is a good fit probably. However if you're more interested in IB/PE then MBA is better imo bc connections and alumni networking advantage.
Regardless, passing cfa level 1 will still show employers you're serious about finance imo. Also, if you like analyzing stocks, working on the CFA will only help I think
do u mind like maybe not showing ur face that much when u r explaining? would prefer to straightaway see the numbers with the sound in background
Sure, I'll take that into account
no dont do that, dumb comment.@@PeakFrameworksu have a nice face