Case 094Paper LBOsCore
Paper LBO with fees and a rollover: EBITDA Rs 60 crore at 9x, fees of 3% of EV, 4.5x debt, management rolls Rs 30 crore. EBITDA reaches Rs 90 crore in year 5, debt falls to Rs 150 crore, exit at 9x. What is the sponsor's MOIC and IRR, and what did the fees cost?
1The situation
A sponsor buys Vistarak Packaging, a maker of flexible packaging for food brands, at 9x EBITDA of Rs 60 crore. Transaction fees, advisers, financing and diligence, come to 3% of enterprise value and are paid at closing. Lenders provide 4.5x EBITDA. The management team rolls Rs 30 crore of its sale proceeds into the new equity alongside the sponsor.
Five years later EBITDA is Rs 90 crore, debt has been paid down to Rs 150 crore, and the business is sold at 9x.
2Your task
Build the sources and uses, work out the sponsor's ownership, then its proceeds, money multiple and IRR, and say what the fees cost in return.
Quick check
Fees are 3% of EV. Roughly what do they cost the sponsor in IRR over five years?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The sponsor makes about 2.31x and an IRR near 18%; the fees cost about 1.4 points of IRR. Uses are Rs 540 crore plus Rs 16.2 crore of fees; debt covers Rs 270 crore, management rolls Rs 30 crore, so the sponsor writes Rs 256.2 crore and owns 89.5% of the equity. Exit equity is Rs 810 crore less Rs 150 crore, Rs 660 crore, of which the sponsor's share is Rs 591 crore.
Step 1What do the fees and the rollover do to the sources and uses?
They change the cheque, not the business. When you buy a flat, the stamp duty and the broker are paid by you on top of the price, and the seller who keeps a room in the flat has not reduced your loan. Uses are the Rs 540 crore price plus Rs 16.2 crore of fees, Rs 556.2 crore; debt of 4.5x is Rs 270 crore, so equity must be Rs 286.2 crore, of which management's Rs 30 crore rolloverSale proceeds that the selling managers reinvest into the new company, so they own part of the equity alongside the sponsor. covers part and the sponsor writes Rs 256.2 crore. The sponsor therefore owns 89.5% of the equity, and that percentage is the number the rest of the question hangs on.
Step 2What does the sponsor get at exit?
Exit equity first, then the share. Rs 90 crore at 9x is Rs 810 crore; less Rs 150 crore of debt leaves Rs 660 crore of equity; the sponsor's 89.5% is Rs 590.8 crore on Rs 256.2 crore in, 2.31x, and 2.3x in five years is an IRR of about 18%. Management's Rs 30 crore becomes Rs 69.2 crore, the same multiple, because the rollover bought ordinary equity at the same price; a management incentive plan on top of that would dilute the sponsor further and belongs in the follow-up.
| Rs crore | With fees | Without fees |
|---|---|---|
| Uses | 556.2 | 540 |
| Debt | 270 | 270 |
| Management rollover | 30 | 30 |
| Sponsor equity | 256.2 | 240 |
| Sponsor ownership | 89.5% | 88.9% |
| Sponsor share of exit equity of 660 | 590.8 | 586.7 |
| MOIC and IRR | 2.31x, 18.2% | 2.44x, 19.6% |
Step 3Why do fees cost less than 3% of IRR, and why do they still matter?
Because they are a one-off cost spread over a five-year compounding period. The fees lift the sponsor's cheque by Rs 16.2 crore, 6.7%, and a 6.7% larger denominator over five years is about 1.4 points a year. They matter because they are paid in equity, the most expensive money in the deal, and because a shorter hold makes them hurt more: the same fees on a three-year exit would cost over two points. That is why sponsors negotiate adviser fees hard, push financing fees onto the company's balance sheet where lenders allow it, and why a paper LBO that ignores fees overstates the return by a measurable amount.
Where candidates lose it
The usual loss is leaving fees out of uses, or putting them in and still dividing exit equity by the sponsor's cheque as if the sponsor owned 100%. The rollover means the sponsor owns under 90%, and the exit must be shared in that proportion.
The second is treating management's rollover as debt or as a free option. It is ordinary equity bought at the same price, and it earns the same multiple as the sponsor's money.
What the interviewer asks next
- Management also gets a 5% option pool that vests at exit. What does the sponsor's multiple become?
- Financing fees of Rs 8 crore are capitalised and amortised rather than paid from equity. How does that change the sources and uses and the return?
- At what hold period would the fees cost the sponsor 3 full points of IRR?
Asked at Warburg Pincus, Private Equity, New York, 2020 (Wall Street Oasis): second round was technical (accounting, investing considerations), third round was an LBO
Company names and figures are illustrative.