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What is Leveraged Buyout Modeling?

Jim B.
Jim B.

Leveraged buyout modeling is a technique used by a private equity company to determine the financial implications of performing a leveraged buyout of another company. Since a leveraged buyout is usually accomplished by the acquiring company borrowing the majority of the amount needed to buy, it is important to know if the buyer can pay back its creditors. For that reason, typical leveraged buyout modeling includes inputting all of the financial data of the company about to be acquired. The company performing the buyout must also take into account the planned debt structure and the interest rates that will be due on any required loans.

Companies in financial trouble are often absorbed by other private equity investors. These investors generally install new management and apply their expertise to try and increase the business of the new company, thereby improving the value of their purchased shares. When the purchase of a company is financed largely through loans, is known as a leveraged buyout. Leveraged buyout modeling is a way for private equity investors to project the value of their investment.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

It is important to understand when undertaking leveraged buyout modeling that the private equity company often uses the assets of the target company as collateral for the loans needed to buy it out. This means that the new business must generate enough income to pay back those loans first before investors can turn a profit. In some cases, the private equity company may be able to finance some of the purchase from its own money, which would necessitate less of a debt obligation.

The most important elements of the leveraged buyout modeling process are the financial records of the company to be purchased. These include earnings levels, cash flow levels, preexisting debt obligations, and any assets and liabilities included on recent balance sheets. From these, the new company should be able to extrapolate what future earnings levels might be. This can give the investors a good idea about how long it will take them to pay down their debt.

There are other considerations to be taken into account when performing leveraged buyout modeling. Investors need to realize that they must not only pay back the principal of all their loans but also the promised interest payments to the lenders. For that reason, all applicable interest rates must be entered into the leveraged buyout model to produce an accurate financial picture of the new company.

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