LBO Model: Sources & Uses
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- Опубликовано: 27 янв 2014
- Learn more here: breakingintowallstreet.com/co...
Why Does the Sources & Uses Schedule Matter? Key part of an LBO (leveraged buyout) model -- what you're paying for (the Uses) must equal how much you're putting in (the Sources).
Similar to the conservation of energy or momentum in physics, money must be conserved in a transaction like this -- cannot be created or destroyed.
But the real point is that this schedule determines the amount of CASH (equity) the private equity firm must contribute to a leveraged buyout transaction.
Higher cash contribution = lower IRR, all else being equal, and lower cash contribution =
higher IRR, all else being equal.
This schedule also tells you the OWNERSHIP in a company post-LBO -- can add up the cash contribution from all parties (e.g. PE firm, Founder, management team) and divide each contribution by the total to get the ownership percentages.
And it explains why activist shareholders like Carl Icahn often hate these types of deals -- can hugely increase the Founder's stake or management's stake, and remove all upside from the existing shareholders!
What Goes Into a Sources & Uses Schedule, and How Do You Build One?
Uses Side -- Most common items are the Equity Purchase Price of the company (how much it costs to acquire all their shares), plus transaction fees, and any debt that is repaid in the course of the deal.
Sources Side -- The most common items are all the different types of debt you use to buy the company, and then the cash (equity) the PE firm contributes to close the gap.
How to Calculate It:
1. Always START with the Uses side and calculate everything there, adding up the total at the bottom.
2. Then go to the Sources side and link in all the debt (and other funding sources) you're using.
3. Then, calculate Investor Equity by setting it equal to Total Uses -- "Sources So Far" -- all the sources of funding ABOVE the Investor Equity line item.
4. Finally, add up Total Sources at the bottom and ensure that it equals Total Uses.
More Complex Items for the Sources & Uses Schedule:
Debt Assumed -- This appears under BOTH the Sources AND the Uses sides and has no impact on the cash required to do the deal. It simply stays on the Balance Sheet, so it's both a Source and a Use of funds and doesn't impact us at all.
Excess Cash Used -- The company uses its own cash to purchase some of its shares required to complete the deal. This REDUCES the number of shares the PE firm must buy, and therefore reduces the amount the PE firm must pay, so it's a Source of funds.
Founder or Management Rollover -- If the Founder or management team owns a % of the company now and wants to keep it, this also reduces the amount the PE firm pays -- and therefore it's another Source of funding and only appears under Sources.
Additional Cash Contributions -- The Founder or management team or other parties can also "up" their stake in the company by putting in additional cash into the deal. This reduces how much the PE firm must contribute, and increases the ownership of these other parties.
Rules of Thumb for All of These:
If an item DECREASES the cash a PE firm must contribute, it goes on the Sources side.
If an item INCREASES the cash a PE firm must contribute, it goes on the Uses side.
If an item makes NO IMPACT on the cash a PE firm must contribute, it goes on both sides of the schedule and is both a Source and a Use.
So Why Did the Dell LBO Piss Off Shareholders So Much?
Because Michael Dell went from owning ~15% of the company to ~78% and only put in a bit of extra cash to do so. And the company used its own cash to fund much of the deal.
They said to shareholders, "Hey, we're going to buy your shares at a low-ball price and use our excess cash to buy many of them -- we could have issued that cash to you as a big dividend and let you keep their shares, but we're going to instead buy them from you at a fairly low price and remove any potential upside you have in this deal."
What Next?
Find a deal you're interested in and try to create your own Sources & Uses schedule for it, based on press releases and company filings.
And be prepared for these questions in interviews, case studies, modeling tests, and more -- this schedule is critical to all types of transaction modeling.
Why wasnt I told about this 7 years ago? Excellent. Concise, explanatory and practical!
Thanks for watching!
What a moral of the story. You're doing a great job in there! Thanks!
Thanks for watching!
Very well done! You really make the best finance tutorials on RUclips.
+Elyse Lam Thanks for watching!
Hey! Thanks for making such great tutorials! It is really easy and fun to learn this way.
+Shrawan Mundra Thanks for watching!
Love it!
Fantastic examples and presentation!
Thanks for watching!
Great class, as always!! In terms of returns, I understand that not all factors of the deal change the sponsor's, return, right? I believe that the factors that impact the TOTAL amount of equity in the deal (both sponsor, rollover and extra cash from management) affect the returns (this is the case for company cash and debt). However, I believe that the factors that only change how the amount of equity in the deal will be distributed among shareholders don't affect the returns (this is the case for sponsor, rollover and extra cash from management). Is that right? This is what my model yields after constructing an LBO following your classes. Thank you very much.
You're asking a question that is beyond the scope of these free tutorials, but if you measure the returns drivers at the company-level, yes, the distribution of equity and possible changes to it (e.g., waterfalls, earn-outs, option pools) do not affect the returns from sources as measured in a returns attribution analysis.
Thanks so much for the video, quite clear and helpful! Is there any chance we can get the excel models for the cases mentioned in the video?
There is no Excel file for this video, but there are similar files with Sources & Uses schedules throughout our channel.
Hello Brian. Thank you for the informative video. Could you explain why you suggest using Equity Value for public company vs. Enterprise Value for private company? In both cases what we are buying in the end is the total value of shares outstanding (Equity Value).
You could use Equity Value or Enterprise Value for either one. But deals for private companies are often based on Enterprise Value rather than Equity Value because private companies do not have publicly traded shares with easy-to-determine prices that you can apply a premium to.
Thanks. Very useful instructions. Btw, how (or what application) do you use to annotate your presentation (e.g. draw a blue rectangular box around text)?
It's a part of Camtasia Studio, the screen capture software used here.
Mergers & Inquisitions / Breaking Into Wall Street i see. Thanks!
Many thanks for the presentation, super useful. Question: if there is a minimum cash amount required at close, and the firm has cash at close as well. Does the minimum cash amount appear on the uses part ? (I saw a case where the companyh had no cash at close, therefore the minimum cash amount had to be funded by the PE fund, but what if the company already has cash, should the minimum cash amount still be shown on the "uses" section?) Many thanks!
It depends on how the company's cash balance at close compares to the minimum. If it's less than the minimum, it is a Use, and the PE firm has to contribute something to pay for it (or use the debt issuances to pay for it). If the company's cash balance exceeds the minimum, then nothing would show up under Uses, and you might potentially show some of the excess cash under Sources as a way to fund the deal.
Hi, thanks for your presentation. Would like to clarify, in reality, how are the new ownership percentages actually determined? It seems in the model that it's part of a mathematical calculation, by using the new investor equity as a plug. However, i've received differing opinions from a university professor, who claimed that the ownership percentages are a result of a series of negotiations with the PE sponsor. Would certainly appreciate some light on this matter regarding the chronology of the process. Is it these negotiations that decide how much the owner contributes (cash) or rollover equity is involved, thereby affecting the ownership percentages? Or are these simply mathematical calculations (plug) like how you described in the video? thanks so much!
+ernest ong Sure, maybe you can negotiate slightly different percentages, but as a practical matter the ownership is determined by the % equity contribution from both groups of investors (existing and the new PE firm investors). You wouldn't really see a case where the PE firm should own 80% but then the company "negotiates" and the PE firm ends up owning 60%... what would the rationale be? They just felt like being nice guys? The company's management team kidnapped their families and demanded a reduced ownership percentage?
There may also be some differences if the firm is investing using preferred equity rather than common equity, but that is more relevant to venture capital (i.e., acquiring minority stakes in companies) than private equity (acquiring entire companies).
Very helpful video, I just have one question: When talking about using the existing cash balance to buy back shares before the deal, wouldn't that cause a share price increase, since the buyback price would have to be above the market value to convince shareholders to sell? In this case, wouldn't it make more sense to pay a higher equity amount at first and issue a dividend of the entire cash balance (assuming net income is high enough to comply with dividend restrictions, otherwise just pay off debt quickly). This dividend would still happen during the same time period as the acquisition (=same year -> no discount in NPV equation) and would therefore effectively lower the initial equity investment and not affect IRR.
So what is the reason that a share buyback (with the possible increase in share price it leads to) is preferred to the method described above?
That could theoretically happen, but the typical assumption in models is that share issuances and repurchases do not affect the company's share price. The impact on the share price depends on the amount of shares being repurchased as well. No premium is necessarily required if it's a small percentage of the overall shares outstanding and/or if many existing shareholders purchased at much lower prices, i.e., prices below the offer price per share in the deal.
Excellent video once again !
Isn't Revolver(drawn), part of existing debt. So according to your rule of thumb, if its assumed, it should be on both sides and if has to be repaid, on the uses side. Why is it on sources side instead ?
The Revolver(Drawn) on the Sources side of the Dell schedule refers to the *new* loans that will be issued to fund the deal, not to the existing Revolvers or other debt the company has before the deal takes place.
@@financialmodeling Thanks a lot !
this guys good
Thanks for watching!
Hello and thanks again for the video! Could I maybe ask something about the takeover process. Here it is assumed that the PE company + the founder always buy 100 percent of the company, but even if it were to be less, how could this potentially oblige a regular shareholder to sell its shares. What if most of the other shareholders decide they don't like the takeover and will not sell their shares? Or if just me as individual decide that I want to stay in the company for the potential upside in the future - what can prevent me from doing this?
+ReckStyle It depends on the type of agreement that gets negotiated, but as long as the PE firm controls the majority of the shares, it can do whatever it wants. Sometimes minority shareholders have protection against this, but that gets into a complicated and off-topic discussion that we're not going into here. If the deal is directly negotiated with the company and the Board agrees to it, that's it: you can't really do anything if you only have a small percentage of the company, other than try to get a majority of shareholders to rebel and vote against the agreement.
Thank you very much for the video! Very instructive, like always.
I have a question related with the % ownership. Why do we take into account fees paid in order to determine the % of ownership? E.g. if equity value = 100, fees 10, no debt and rollover equity = 20% (wants to maintain 20%), I understand it's 20% of 100 (i.e., 20), right?. Investor equity = 90 (=100+10-20). 90/110 = 81.8%. So rollover equity doesn't maintain 20%.
Alberto
Fees should not make a major impact on ownership. However, they may impact ownership a bit because higher fees mean that more equity/debt is required to fund the deal. If you assume that the additional equity comes only from the sponsor, the ownership will change. The easiest way to get around this is to assume that the rollover equity contributors and the sponsor contributing new equity do so based on %'s of the total equity required rather than assuming a fixed dollar amount for the rollover. But it makes such a small difference in practice that it doesn't really matter. Your example with fees worth 10% of the equity value wouldn't happen in real life - if the fees were that high on a real deal, the company would fire the bankers or not even go through with the deal.
Thank you very much for your answer! In my example, I inflated fees to make clear my exposition. I don't see very clear your explanation conceptually. I'm pretty sure that none of the companies I know here in Europe would accept to make any concession of ownership due to the fees paid to professionals advising in the transaction. Even if it's 1$ fees (again, I'm exaggerating). It's a concept matter. Again thank you for the video! Best regards,
Alberto
The point is very simple: fees will impact ownership ONLY if equity is used to pay for those fees. If it is not - i.e. debt is used instead - then the fees will not impact ownership because they simply increase the amount of debt required to fund the deal. That is usually what happens in real life, but sometimes this gets lost in models depending on how the Sources & Uses schedule is set up.
thank you for the explanation!
Great video! I understand why assuming existing debt falls under uses (you need to pay out the debt holders of the target company), but why does it fall under sources?
To indicate that the existing Debt affects neither the funding required for the deal nor the money that is being used to pay for the deal.
@@financialmodeling Quick follow up -- if assuming debt does not affect the funding required for the deal, why does it even appear on sources and uses in the first place? I also know you have mentioned that existing debt almost always gets repaid due to change of control clause -- is the exception when debt is assumed and stays on the balance sheet?
@@johnjohnson8465 It is in the schedule mostly to clarify the treatment. Debt is hardly ever assumed, but if it is assumed, yes, it stays on the Balance Sheet.
Hello. Many thanks for this and other wonderful tutorials. I have a question about the distribution of ownership stakes before and after the LBO transaction. When you sum up the stakes owned by M. Dell and Silver Lake, Dell ends up owning 78.1% compared with 15.2% prior by retaining his initial minority stake and buying up some additional stock with cash. What I do not understand is why Silver Lake's stake after the LBO is so small whilst the one of Dell is so high, assuming that it was Silver Lake that assumed debt to buy stock from the institutional investors. You say at one point in the video that debt does not lead to stock ownership, but this is from the perspective of the lender (unless debt is convertible). However, as far as Silver Lake is concerned, it is borrowing money to buy a majority stake so it should actually replace the institutional investors with their 80%+ collective stake. Thank you!
+George Voloshin Silver Lake's stake is so small because it mostly borrows money to buy Dell. It uses very little of its own equity (i.e., cash on hand). When a PE firm borrows money to buy a company,, it will not own that portion of the company's equity. That is because the *new shares* in the company are created based on the total equity invested in the company... so if debt rather than equity is used, shares are not created and there's nothing available for anyone to own.
Thanks a lot for your explanation!
@@financialmodeling So if the deal was funded 100% by debt, would that mean that Silverlake owns nothing on the company, and Dell retains all of its ownership? Also, isn't the point of an LBO for the PE firm to gain majority stake in the firm being acquired? Why does Silverlake only have 15% stake after the LBO? It just doesn't make sense. Thanks.
@@arjunarun9174 No LBOs are ever 100% debt funded because no lenders would agree to fund such a deal, so this scenario is not plausible. Lenders always want some minimum amount of equity before they'll commit to debt funding. Most LBOs are based on majority stakes, but this does not always happen for various reasons (such as management rollovers), and some PE firms do growth equity-style deals with minority stakes as well.
Why my sources not equal to the uses? I've searched for every mistyped numbers, but still not equal. There is a 20.000.000.000 difference between, that number is quite small compared to other 13-14 digits number in the sheet. Can you help me?
We provide Excel support only for clients and customers of our courses. If you have signed up for a paid course, feel free to email us with your question.
Thanks Brian. Quick question on the Dell case study and using excess cash on the balance sheet as a 'Source': is the $24.6bn equity purchase price not including this excess cash of $6.2bn already? i.e. would the existing shareholders not want the excess cash to be paid out to them rather than let it be used by the sponsor to take the company private (because this excess cash belongs to the existing shareholders and is part of $24.6bn equity purchase price)? I guess more broadly my question is whether the equity purchase price already includes excess balance sheet cash in the pre-take-private EV-to-equity bridge.
Yes, the shareholders would want the excess cash paid out to them instead. This is why the deal was so controversial - Michael Dell greatly increased his ownership, and the shareholders did not get the cash distribution they wanted. Instead, they received a somewhat sub-par offer price for their shares. The Equity Purchase Price includes the Net Assets of the company, so it reflects the value of all the cash. But this is mostly an issue if the company has a huge amount of excess Cash, in which case it becomes a controversy / deal negotiating point to decide what to do with it.
@@financialmodeling Thanks a lot Brian - to use a simplified example, would the following be accurate:
Say a company has EV of $100 and $50 of excess cash (and no gross debt) on the balance sheet. So the equity value is $150. The existing equity holders (i.e. sellers) would expect $150 for the buyer to buy the company. Is this correct? Or can the buyer use the $50 excess cash on the balance sheet as part of the $100 to pay to buy the EV of the company (and so the sponsor equity cheque size is only $50). Or how would you think about the sources and uses in this example? Assuming debt-free cash-free basis in one scenario and assuming debt-free but $50 excess cash on the balance sheet in the second scenario. EV is $100 in both cases.
Thanks! In the first example, why excess cash is not a use of fund?
Excess Cash is always a Source of Funds because the PE firm can "take" a company's excess cash for itself when it completes the deal, reducing the purchase price.
Awesome Video ! Anyway we can access these excels ?
You can find similar files in other LBO tutorials in this channel. Click "Show More" and scroll to the bottom.
hey can you please explain the part where Michael dell went from having a 15.2 % share to 78.1 %, what happened to the institutional investors share of 84.8 %
It's because he rolled over his shares while the Equity in the company decreased dramatically due to the high amount of Debt used to fund the LBO. The same share count / much smaller Equity = much higher ownership percentage. The institutional investors all left because their shares were purchased for the offer price in the deal (except for maybe a few who also rolled over shares).
If I understood the concept correctly, the shareholding structure of the bought out company is revised after and LBO and the PE firm gets equity corresponding to the amount of cash they invested in the deal. But an existing shareholder who holds out gets a disproportionately larger shareholding after the deal because of the low equity invested by the PE and the PE firm gets a much smaller share.
Does this not defeat the purpose of the LBO? The PE firm in the Dell case did not even get a majority shareholding of Dell after the deal?
It doesn't defeat the purpose of the deal because the PE firm still ends up having significant control over the company, and the "majority owner" isn't exactly in control because he couldn't have done the deal without the PE firm in the first place. The Dell scenario is a bit unusual; most deals don't work like that because it's very rare for the founder's ownership to jump up by a huge amount. The normal scenario is for the management/owners to retain only a small percentage of the company.
Can you please upload xls sheet for this video? Thanks in advance.!!
It's available in our courses and in some of the free tutorials on the site - I can't post links in comments, but if you go to M&I and look up the Dell case study there are examples there.
Thanks for the video. Please would you be able to explain the minority equity rollover? Example if an LBO of a €100m EV company that today is fully equity funded and the current holder wants to roll half their equity. If the PE firm leveraged the company with €50m of debt, would they pay €25m for half the equity, such that the rolled equity is now worth €25m (given the leverage, totalling €50m debt and €50m equity) with the previous owner receiving the €50m debt raise and €25m equity purchase for €75m (and thus the balance of their original €100m equity). Does that work? I.e. the more leverage the less the rolled equity stake value
The equity rollover must be viewed in relation to the debt funding for the deal because the debt funding determines how much equity is actually available to roll over, as they both appear on the Sources side. So in your example, yes, the PE firm would pay 25M for half the equity, and the previous shareholders would get the proceeds for the 75M worth of shares they are selling in the deal.
How can we get your showcased spreadsheets, are these free to download?
There is no spreadsheet for this one, but there are many examples of Sources & Uses schedules in other spreadsheets in this channel.
I am a visual-touch-n-go kind of learner if we purchase your program are all templates (similar as showcased) in your packages?
All Excel-based lessons have Before/After Excel files.
Wait, why is existing debt a source of funds?
+hurf_durf It's not. It is both a Source and a Use of Funds, because it stays the same and has no net impact on the funds required to do the deal or the funding available for the deal.