Cash-Free Debt-Free Deals in M&A and LBOs (Version 2.0)

[@financialmodeling]

For the files & resources, please go to: breakingintowallstreet.com/kb/leveraged-buyouts-and-lbo-models/cash-free-debt-free-basis/ Table of Contents: 0:00 Introduction 5:53 Part 1: Simple Public vs. Private LBO 10:22 Part 2: 3-Statement LBO Example 18:21 Part 3: M&A Example 19:53 Part 4: Equivalence of CF/DF Deals 23:46 Recap and Summary

[@JohannesPorphyrius]

I love your videos. I got my master from a good ranked European school, but we only did theoretical finance. Nothing related to what you do at work. These videos are really an eye opener, and the quality is superb. Thanks a lot!

[@financialmodeling]

Thanks for watching!

[@wenkaiyang1487]

It is an absolutely treasure. very few would cover such a great ground work.

[@financialmodeling]

Thanks for watching!

[@obaialhasson9576]

Thanks for providing us with the written version of this tutorial. Great job 😉✌️

[@financialmodeling]

Thanks for watching/reading!

[@gracedai6020]

Thanks for the great tutorial, you aced it. I still have one more question, might be odd, though. In a particular PE LBO over a privately-owned company under a CFDF basis, while I do understanding the purchased value is the Enterprise Value due to the use of an Entry EV/EBITDA multiple, but why in the use of fund section the existing net debt (pre-LBO) is not deducted before adding other incremental costs - financing, cash to B/S, transaction? My understanding is the acquired (target)'s EV is the sum of (1) purchase equity value and (2) existing Pre-LBO Net Debt and, without the deduction of existing net debt in the use of fund side, the sponsor is technically financing the payoff of existing net debt via new loans and new equity funds from the sponsor. Since it's a CFDF deal, the payoff of existing net debt should be the responsibilities of the original shareholders right?

[@financialmodeling]

It is, but the point is that the new buyer *pays extra* because of that existing Debt. So the selling shareholders then divert some of the proceeds to the repayment of their existing Debt before they can claim the rest of the proceeds for themselves. Deducting the Net Debt would not make sense because then we'd be saying that the buyer does not have to pay anything extra for that existing Debt.

[@Erica_ah]

Thank you

[@financialmodeling]

Thanks for watching!

[@bklwealth1132]

Very helpful man thanks. Happy Thanksgiving

[@financialmodeling]

You too! Thanks for watching.

[@sicelyli5102]

Could you quickly explain why in [9:07] the "assume/replace target's debt" is part of the sources too? I understand that if you refinance, you obtained new debt issuance so that counts as a source, but what about when you just assume the debt? Why is that a source of funding too?

[@financialmodeling]

Assuming Debt counts as a Source because when you assume Debt, it appears on *both* the Sources and Uses sides to indicate that it makes no net impact on the deal funding. So it cancels itself out, and you show it in the S&U schedule to indicate that there are no changes to the company's existing Debt balance. The only real difference vs. refinancing is that if a company refinances, there may be additional fees and the interest rates and other terms will likely change.

[@remyely8479]

Thank you very much from france ! you help me a lot

[@financialmodeling]

Thanks for watching!

[@psaurians]

Do I understand it correctly that even if the DFCF rule is applied in a transaction there still should be some minimal cash reserves left to sustain the company's operations? Is it a common practice that some level of "the operational cash" is actually included in the NWC as a part of the deal negotiations? Thank you in advance for clarification! :)

[@financialmodeling]

A company always needs a certain Minimum Cash to continue operating. So, yes, even if a deal is "cash-free debt-free" it just means that Cash and Debt are temporarily removed... and then put back into place immediately. Operational Cash could be considered part of the company's Working Capital, but it's usually part of the definition of cash-free/debt-free and what happens logistically after the deal closes.

[@psaurians]

@@financialmodeling thank you for the prompt reply.

[@hivatu]

why did you add the assume debt in sources section for no-CF/DF deal in the first example, but not in the second case?

[@financialmodeling]

There are many examples shown in this video, so I don't know which ones you're referring to. Could you please give time stamps? If you're referring to the second 3-statement LBO example shown starting at 10:22, there are still lines for Refinance Debt or Assume Debt, it's just that we separated them out. But it's the same as writing "Assume/Replace Debt" because in either case, the target company's entire existing Debt balance appears on the Uses side.

[@hivatu]

​@@financialmodeling yes, that one. But why doesn't it appear in the sources side as well, similar to 9:00?

[@financialmodeling]

@@hivatu Because in the example at 9:00 we are separating out the existing Debt from everything else, but in the segment at 10:22 we are not. In other words, a $50 portion of the $119 in Term Loans + $79 in Subordinated Notes corresponds to "Assumed/Replaced Debt," just like a $50 portion in the Sources & Uses right below it corresponds to the $50 in Refinanced Debt. We could rewrite this Sources side as "$50 in Assumed/Replaced Debt" and $69 in New Term Loans + $79 in New Subordinated Notes (for example). Most people do not show Assumed/Replaced Debt on the Sources side of a Sources & Uses schedule in real life; it's done here for teaching purposes in a few of the examples.

[@hivatu]

@@financialmodeling awesome thanks much!!

[@Josh-zw1ui]

In the CFDF example, the buyer has to fund the minimum cash of $10m? Meaning they are actually paying $10m more than if done in a non-CFDF basis. Why would they do this? My understanding is the $10m min cash in uses would then come from excess cash in sources meaning the buyer would not fund the minimum cash

[@financialmodeling]

They are not paying more than in a non-CFDF deal. They are economically equivalent. The difference is that in a non-CFDF deal, "Excess Cash" appears on the Sources side, so effectively it takes Total Cash and subtracts the Minimum Cash. That is equivalent to subtracting Total Cash on the Uses side (within Purchase Enterprise Value) and showing the Minimum Cash as a positive entry on that side.

[@zenrelaxation5232]

How would you go around determining the minimum cash balance in real deal? (20% of EBITDA is just a simple assumption if I understand correctly) Would you base it on Wocap?

[@financialmodeling]

You might look at the minimum cash level the company had historically vs. revenue, EBITDA, operating expenses, etc. You could also look at something like the cash conversion cycle if you have more detailed information.

[@psaurians]

@@financialmodeling OK - so having the Cash Conversion Cycle calculated and then what? Multiply the CCC by, say the daily operational expenses? And the result would be the minimal cash level?

[@financialmodeling]

@@psaurians Potentially, yes. But in modeling tests and case studies, the most common method is to simply make the Min Cash a % of Revenue, OpEx, or even a simple constant number.

[@Chachiboyss]

Thanks for this great tutorial. Could you please explain the following: suppose I want to buy a private company in the next couple of months (it’s now Nov-23). The seller wants to close the transaction based on 2022 actuals and these numbers are available (the 2023 numbers obviously aren’t yet). Say we buy the company on a cash and debt free basis, for a purchase price of $1m. The seller argues that the final purchase price should be equal to $1m minus net debt as per 2022A (cash minus ST and LT debt as per 2022A), plus the receivables as per 2022A. Then the seller argues that there should be a final settlement based on the 2023 numbers once these are available. Now my questions are: (i) why still play for the receivables of 2022A? Is that fair? (ii) what should we take into account when negotiating the final settlement based on the 2023 numbers? What would a typical calculation look like? Would be great if you can help. Thanks a lot in advance!!

[@financialmodeling]

If you assume that the Purchase Enterprise Value is $1M, then yes, the Proceeds to the Seller should be $1M minus Net Debt since that equals the Purchase Equity Value. To answer the question about the Receivables, we need more information because it's unclear what the targeted or normalized Working Capital level is. If the WC at close is more or less than this targeted level, then you have to adjust the Purchase Enterprise Value accordingly, and the Proceeds to the Seller will also change. But without that targeted or normalized level vs. the actual level at close, we can't answer this. You may want to see this for an overview: kzbin.info/www/bejne/pZKblYh_eNGogq8

[@Chachiboyss]

@@financialmodeling Great, thanks a lot!