The Daily Technical #27: Would an acquirer prefer $100 in revenue synergies or $100 in cost synergies?

Good morning. Welcome to the 27th edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
What is a leveraged buyout (LBO)?

In a leveraged buyout, a private equity firm (often called the financial sponsor)
acquires a company with most of the purchase price being funded through the use of various debt instruments such as loans and bonds. The financial sponsor will secure the financing package ahead of the closing of the transaction and then contribute the remaining amount.

Once the sponsors gain majority control of the company, they get to work on
streamlining the business – which usually means operational improvements,
restructuring, and asset sales intending to make the company more efficient at generating cash flow so that the large debt burden can be quickly paid down.

The investment horizon for sponsors is 5-7 years, at which point the firm hopes to exit by either:

• Selling the company to another private equity firm or strategic acquirer

• Taking the company public via an initial public offering (IPO)

Financial sponsors usually target an IRR (internal rate of return) of ~20-25% and a MOIC (multiple on invested capital) of 2.5-3.5x when considering an investment.

Common Mistakes

1. Failing to emphasize the role of debt in funding the acquisition. Always stress that the majority of the purchase price is covered using various debt instruments.

2. Overlooking the operational improvements and asset optimization post-acquisition. Remember to explain that these steps are essential for increasing the company's cash flow and paying down the debt effectively.

3. Forgetting to mention the exit strategies or target returns. Make sure to cover how the firm plans to exit the investment and the financial goals, which are vital parts of a complete LBO explanation.

Key Takeaways / TLDR

• LBOs involve acquiring a company using mostly debt, with financial sponsors leading the charge.

• Post-acquisition strategies focus on operational improvements to boost cash flow.

• Typical investment horizon: 5-7 years, aiming for a 20-25% IRR through sale or IPO.

TODAY’S QUESTION
Would an acquirer prefer $100 in revenue synergies or $100 in cost synergies?

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THAT’S A WRAP
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The HirePrep Team