Valuing Late-Stage Companies and Leveraged Buyouts

Abstract

This note replaces "Valuation of Late-Stage Companies and Buyouts" (UVA-F-1639).This note focuses on the valuation of late-stage companies with a particular emphasis on leveraged buyouts (LBOs). In contrast to venture capital, where firms are typically at an early stage of development, late-stage investments involve more-established businesses that have an ability to take on higher levels of debt to augment investor returns. The note provides a description of LBOs, an overview of the commonly used sources of financing and the metrics used to assess LBO capital structures, a discussion of the value drivers of buyouts, and a step-by-step example of an LBO analysis. This note takes the perspective of private equity (PE) investors and assumes some basic familiarity with the structure of PE investing. Their approach is compared to other discounted cash flow valuation methods based on the weighted-average cost of capital or adjusted present value.

Excerpt

UVA-F-1846

Aug. 23, 2018

Valuing Late-Stage Companies and Leveraged Buyouts

This note focuses on the valuation of late-stage companies with a particular emphasis on leveraged buyouts (LBOs). Late-stage investments can arise in situations involving growth equity, turnarounds, mezzanine investments, and distressed debt. In contrast to venture capital, where firms are typically at an early stage of development, late-stage investments involve more-established businesses that have an ability to take on higher levels of leverage to augment investor returns. This note takes the perspective of a private equity (PE) investor and assumes some basic familiarity with the structure of PE investing. It provides a basic overview of the primary sources of financing, the metrics used to gauge LBO capital structures, and a step-by-step example of an LBO analysis.

What is an LBO?

An LBO is the purchase of a firm by an outside individual, another firm, or the incumbent management using large amounts of debt to finance the purchase. The target firm for an LBO can be a freestanding private or public company or a division of a company. Most often, LBOs are undertaken by PE firms that specialize in these transactions (e.g., Blackstone, Carlyle Group, and KKR). PE firms that specialize in LBOs are often referred to as sponsors, because they in effect sponsor or propose the deal. Unlike strategic buyers, who often have assets or expertise to combine with the target firm, sponsors are typically financial buyers whose expertise lies in arranging the financing and incentives for management to perform in a highly leveraged transaction (HLT). That said, sponsors must also have a keen eye to identify opportunities for business development and operating improvements.

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Keywords: leveraged buyouts, LBOs, valuation, private equity, adjusted present value