4. Transaction Assumptions Part 2

Overview

In this lesson, we estimate the fees from investment banks, debt issuance and legal due diligence that can have a significant impact on the total funds required

Summary

  1. Lesson Goal (00:00)

    The goal of this lesson is to complete the transaction assumptions for the MarkerCo acquisition.

  2. Calculating Transaction Funding (00:04)

    Once we have calculated the amount of funds required to complete the transaction, we can calculate the amount of debt and the amount of equity required. To calculate the debt amount, we multiply the funds required by the debt percentage. To calculate the equity required, we multiply the funds required by the equity percentage.

  3. Calculating Transaction Fees (01:00)

    There are typically three fees associated with a leveraged buyout transaction. They are:

    • Advisory fees: These are paid to an investment bank for their assistance in completing the transaction. They vary based on deal size, and are usually lower when the investment bank is representing the seller. These fees are calculated as a percentage of the purchase price for the transaction.
    • Debt fees: These are fees paid to banks, law firms, and other parties involved in issuing debt. They are calculated as a percentage of the total debt issued in the transaction.
    • Legal and other: These cover all the other fees involved in the transaction. These are usually a low percentage of the purchase price.
  4. Understanding the Minimum Cash Balance (02:49)

    When a company is bought in an LBO, debt repayments can reduce a company’s cash balance quickly. To avoid this, we can specify a minimum cash balance that must be maintained at all times. We can determine an appropriate minimum cash balance by considering the company’s current cash balance, and its liquidity. We can determine both of these by studying the Balance Sheet.

Transcript

In our transaction assumptions table, we know that the total funds required by PrivEq to purchase MarkerCo. are $240 million. So how are we going to source these funds? Well, PrivEq have said they want the total debts to be 70% of the transaction price. Leaving the remaining 30% to be picked up by PrivEq. Let's calculate these percentages in dollar terms. So I'll take the total funds required. Anchor the cell.

Multiply it by the percentage.

And I'll copy down for the equity amount also. Needless to say, if we change one of our assumptions under funds required... maybe moving excess cash to $30 million, then the total debt amount will decrease accordingly. I'll just undo with Ctrl + Z. Now let's move on to fees. Typically, transactions will incur three different types of fees. These are often neglected when calculating investment returns, but can make a significant impact particularly for smaller transactions. Advisory fees are typically incurred when an investment bank is brought in to help with the purchase. These fees can vary depending on deal size and whether the investment bank is representing a buyer or a seller. Investment banks only get paid if a deal closes. This is always more likely when selling a business so the fees tend to be lower when serving a seller. For smaller transactions, investment banks can charge up to 6% as a fee for purchasing a company. But for this transaction, I'm going to assume 1.2% of total equity.

So I'll take my assumption, multiply it by the equity price.

The debt fees are costs associated with issuing the loans and bonds such as various fees and commissions paid to banks, law firms, and other actors involved purely in the debt issuance activity. This tends to be assumed as a percentage of the total debt issued, and for this example, I'm going to set the percentage to 3.2%.

And I'll calculate the dollar amount as well. So I'll take my assumption, multiply it by the total debt amount.

The last set of fees are legal and other. These tend to be smaller than the investment banking fees and in this example, I'll set the percentage to 0.8%. Again, basing this percentage off the purchase equity price.

The last remaining cell we need to fill in in this section is the minimum cash balance. When a company is acquired in an LBO, cash outflows can grow very quickly due to interest repayments on debt. As a consequence, it's always worth putting in a minimum balance as a sense check.

Let's scroll down to MarkerCo's Balance sheet and see how the cash flows are looking.

In previous years, cash and cash equivalents have grown substantially, up to $69 million at the end of 2015.

If we compare current assets and current liabilities, you can also see that the current ratio and the quick ratio are both quite healthy.

While the company is intent on increasing capital expenditure in the future, it's not by a huge amount. And as a consequence, I'm going to leave the minimum cash balance at about $30 million.

And I'll simply enter it in this cell. This can be subject to change as we build the model out further. With our transaction assumptions table complete for now, in the next lesson, we'll move on to the debt assumptions, explaining the different types of debt open to PrivEq on this deal.