Cash-Free, Debt-Free Deals in LBO Models: How They Work
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In this tutorial, you’ll learn what a Cash-Free Debt-Free Deal means, how it works in the context of a leveraged buyout, and how LBO models that use this deal structure differ from ones that use a standard structure.
Table of Contents:
1:19 The Short Answer
5:48 Detailed Changes in the Excel Model
11:43 Additional Questions
12:52 Recap and Summary
QUESTION: “When modeling a ‘Cash-Free, Debt-Free’ deal, and the Target has both Cash and Debt on its Balance Sheet, how do you adjust for it in a 3-statement model?
I know Cash and Debt are both supposed to go to 0, but how do you make sure the Balance Sheet still balances?
Also, how do you record this type of deal in the Sources & Uses schedule?
Do you show the Equity Value or Enterprise Value on the Uses side?
Do you have any examples to show how this type of deal works?”
SHORT ANSWER: In a Cash-Free, Debt-Free Deal, the Target’s existing Cash and Debt balances go to 0 right after the deal closes.
In the Sources & Uses schedule, the Uses side should be based on Purchase Enterprise Value + Transaction Fees; the Sources side has the standard items, such as Debt and Investor Equity.
No “adjusting offsets” are needed as long as Investor Equity acts as the plug and reflects the Cash used and Debt repaid.
The Total Uses increases by the existing Debt and decreases by the existing Cash, which means Total Sources changes as well.
By contrast, in a “standard” (Non-Cash-Free, Debt-Free) Deal, the Target’s existing Cash and Debt do not necessarily go to 0 upon deal close.
For example, maybe the Target keeps some of its Cash on its Balance
Sheet rather than using it to fund the deal.
Or, maybe the Acquirer assumes the Target’s Debt rather than repaying it and replacing it with new Debt.
The bottom line is that there are more “options” and possibilities for the treatment of Cash and Debt in a standard (non-cash-free, debt-free) deal.
Required Changes in Excel-Based LBO Models
We’ll use a simplified LBO model to illustrate the changes here because it’s easier to see the changes with a single, standalone company.
Change #1: We need different Sources & Uses schedules for both transaction scenarios because Investor Equity will change.
Change #2: We need to add some checks for the deal type to the Cash, Debt, and Equity adjustments on the Balance Sheet.
In Cash-Free, Debt-Free Deals, existing Cash and Debt always go to 0.
But in standard deals, they change based on the assumptions for Refinanced Debt and Cash Used to Finance the Deal in the S&U schedule.
Change #3: In the Debt Schedule, we need to check for the deal type and link to the proper version of the S&U schedule for each tranche of Debt (including Assumed Debt).
Our “New Debt” assumptions may change based on the deal type, so we need to check for this case.
Change #4: The IRR and Money-on-Money Multiple calculations at the end need to check for the deal type because the Investor Equity differs in each case.
Do Cash-Free Debt-Free Deals Affect Much of Anything?
In most cases, there is not a huge impact on the model.
In the example here, the IRR changes by ~1-2% in each year depending on the Cash and Debt assumptions – that is something, but not enough to affect your investment recommendation.
There would be more of a difference if the company had a massive Cash balance, but that would also affect a standard deal!
In terms of the mechanics, if the Target’s Debt exceeds its Cash, then the Target uses its entire Cash balance to repay as much Debt as it can, and the Acquirer repays the rest when it completes the deal (higher effective price).
If the Target’s Cash exceeds its Debt, then the Target repays its entire Debt balance, and then it uses the extra remaining Cash to repurchase shares or issue a “Special Dividend” to its shareholders (or something similar).
In either case, the Target’s Equity Value is lower, meaning the deal price is lower for the Acquirer.
Why Cash Free Debt Free, Cash-Free, Debt-Free Deals in LBO Models: How They Work.
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