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3 reasons why LBO is the mother model for any Investment Banking Professional

Leverage Buyouts (LBO) involves a financial sponsor (mostly a PE) acquiring a target using a high proportion of debt and a smaller contribution of equity

1) Fund Raising Nuances: Because of infusion of debt and equity, the LBO changes the existing capital structure of the target. Hence you get to understand how the balance sheet of the target has to be adjusted to include the new debt and infuse equity to create a pro-forma statement.

This becomes a genesis for any fund raising model which involves infusion of either equity or debt into a company

2) Valuation: Because a target is being acquired by the financial sponsor, the conventional valuation methods like FCFF/FCFE, comparable comps, transactions, regression analysis will be required. This valuation determines the purchase price that has to be paid by the financial sponsor

3) Returns Analysis (Waterfall method): LBO requires both debt and equity investors to put their money in target's business. Hence it is important to understand the returns each set of investors generate (first debt and then equity) using a waterfall approach. Metrics like Cash-on-Cash ratio, XIRR, payback period etc. are often used for this.

Needless to say, LBO is a model over and above the conventional 3-statement financial model.

Learning the nuances of LBO helps an analyst to cover many concepts under one umbrella and these techniques can be applied to other fund raising, valuation and M&A projects.


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