Private Equity Modeling Course

For instance, let’s say that a financial sponsor acquires a company for 7.0x EBITDA. If the target company’s last twelve months (LTM) EBITDA is $10mm as of the purchase date, then the purchase enterprise value is $70mm. While not a guarantee by any means, the odds of exiting at a higher multiple improves if the private equity firm is able to implement strategic adjustments such as the ones mentioned above. Once a financial sponsor acquires a company, the firm seeks to gradually pursue growth opportunities while identifying operational inefficiencies where improvements could be made.

Regarding investing, one of the fundamental concepts that can greatly impact your returns is growth. It’s the reward you receive for lending your money or owning a piece of a company. When creating a simple LBO, you generally group all shareholders into a single line item (“Sponsor Equity”) and calculate aggregate equity returns.

Interest Expense Schedule

ROE measures a company’s profitability relative to its shareholders’ equity. Higher ROE indicates efficient use of capital and strong profitability, which can positively correlate with multiple expansions if sustained. It is commonly used in valuation analysis, especially for companies with significant debt or varying levels of depreciation and amortization. A lower EV/EBITDA ratio relative to peers may suggest the potential for multiple expansion.

Income Statement

1. Specifically, it compares a company’s stock price to its book value per share (BVPS).
2. It does happen—particularly in the smallcap space—and it often starts with the kinds of conditions we are seeing right now.
3. The buyer is, therefore, buying low and selling high, just as those who trade securities in the open markets do.
4. In LBOs, the sponsor generally buys a controlling stake in the company.

The term is generally used for private equity, where a company buys a company and subsequently sells it at an increased price. Multiple expansion is a technique used in private equity where an investor sells an asset for an exit price higher than the price they purchased it for. The debt tranches are organized in order of priority – the Revolver gets paid down first, then the Term Loan B, and then the notes. So the Optional Prepayment for the Term Loan B depends on if there’s anything left over after paying down the Revolver. This means that the management team owns at least 10% of the existing equity and agrees to keep 10% invested alongside the sponsor. When delving into the intricacies of investing, one concept that holds significant sway over returns is multiple expansion.

But as you progress further along in a deal, you generally outgrow this approach. Dividend recaps are a way to return capital to shareholders while retaining control of the underlying company. The attached Excel template shows you one method for layering additional transactions on top of your base LBO model. Get instant access to video lessons taught by experienced investment bankers.

Here we’re assuming that the book value of net assets (excluding the existing goodwill) is equal to fair value, so the entire excess purchase price is allocated to goodwill. A sponsor uses debt so that they can buy the company with less of their own cash (equity). Over time, as the company pays down its debt, the equity value will grow as a percentage of the total enterprise value, thereby increasing the value of the sponsor’s investment. And with that, we will wrap up today’s discussion on understanding investment returns from yield, growth, and multiple expansion. Historical instances, such as the dot-com bubble and post-financial crisis recovery, emphasize the significant impact of multiple expansion on the market and investors’ returns. A company’s growth prospects play a critical role in determining its stock price.

Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. In fact, the current situation may be one we look back at as a dream scenario. You can buy companies experiencing high growth at amazing prices, some of which are trading at or below net value. The secret is to embrace the negative sentiment, move counter to emotions and look for the high-growth, low-value companies that are toiling in obscurity. While not as crucial as revenue and earnings growth, looking at ignored nonfarm productivity down 4 2 percent in the fourth quarter of 2020 and underappreciated sectors is also a smart move. The saying goes that the leaders of the last bull market are not the leaders of the next one—and there are many signs pointing to this being the case.

Valuation Multiple Metrics

The multiple in this case would be 4, using the methods of calculation that we demonstrated previously. A multiple tether current price 1 00 usd can be referred to as a valuation multiple because it can be used in the process of valuing a company. In this article, you’ll learn what a multiple is, how to use it, and many instances where the term multiple expansion can be used. Multiple expansion is a form of arbitrage, which is a strategy for trading assets in different markets or derivative forms to take advantage of price differences. Every LBO model should include basic credit metrics, because these metrics and the credit profile will inform debt investors’ appetite to fund the transaction.

In the world of investments, growth refers to the increase in the value of an asset over time. This is an assortment of other financial modeling topics that are applicable to private equity. While each equity waterfall is unique, it’s important to understand this concept, because it surprises many ex-bankers. You’re used to thinking about equity as one or two uniform tranches. But the equity split between the sponsor and the management team can be nuanced and is an important negotiation point.

Since the selling multiple was higher than the multiple at which the company was purchased, there was a multiple expansion of 2x. Multiple expansion is a simple form of arbitrage that occurs when a buyer buys a company with a low entry valuation multiple and then turns around and sells it for a higher valuation multiple. The buyer is, therefore, buying low and selling high, just as those who trade securities in the open markets do. We can then multiply the LTM EBITDA by the sponsor equity contribution multiple to figure out how much the financial sponsor had to pay for the deal to close. Even if the company’s EBITDA remains unchanged at $10mm, if the sponsor exits the investment five years later but at a 10.0x exit multiple, $30mm of value would have been created – all else being equal.

We include the Undrawn Revolver as a debt balance, because the company must pay a small amount of interest expense for the unused commitment. Ending Debt BalancesNow that we have the Mandatory Amortization & Optional Prepayment for each tranche, we can calculate the ending debt balances for each year. Word to the WiseYou’ll notice we’re not limiting the revolver amount by the revolver commitment. We’re doing it this way, because if you limit the revolver but have insufficient cash flows, you wind up with a negative cash balance, which is also wrong. Let’s consider an investor named Andrew, who purchased 100 shares of Microsoft, a tech giant, five years ago. Each share cost $50 at that time, resulting in a $5,000 initial investment.

Multiple 3 revolutionary top stocks to buy now Expansion is when an asset is purchased and later sold at a higher valuation multiple relative to the original multiple paid. At the same time, don’t assume that a company trading at a high multiple has less growth potential than one trading at a low. The P/B ratio tells us the price of the company’s assets relative to its market cap.

Management RolloverIn a management rollover, the management team agrees to “roll over” part of their equity stake as an investment alongside the financial sponsor. A management rollover is not uncommon, and sponsors like it, because it keeps the management team even more incentivized. If check size (how much money a sponsor is able to invest in a single deal) is a concern, a management rollover can help mitigate that.