Valuation of Late-Stage Companies and Buyouts

Abstract

This note focuses on the valuation of late-stage companies with a particular emphasis on leveraged buyouts (LBOs). In addition to LBOs, late-stage investments can arise in situations involving growth equity, turnarounds, mezzanine investments, and distressed debt. In contrast to venture capital, where firms are typically at an early stage of development, late-stage investments involve more established businesses that have an ability to take on higher levels of leverage to augment investor returns. While in practice there are several approaches to valuation, the approach chosen often comes down to which provides the most accurate representation of the situation and perspectives of the parties involved. This note takes the perspective of a PE investor and assumes some basic familiarity with the structure of PE investing. It provides a basic overview of the primary sources of financing and the metrics used to gauge LBO capital structures and a step-by-step example of an LBO analysis. Excerpt UVA-F-1639 Rev. Aug. 7, 2013 VALUATION OF LATE-STAGE COMPANIES AND BUYOUTS Private equity involves a wide range of investment opportunities from venture capital to buyouts. The methods of valuation used to analyze private equity (PE) investments depend on the maturity of the company and the extent of financial information available to forecast company, industry, and macro trends. This note focuses on the valuation of late-stage companies with a particular emphasis on leveraged buyouts (LBOs). In addition to LBOs, late-stage investments can arise in situations involving growth equity, turnarounds, mezzanine investments, and distressed debt. In contrast to venture capital, where firms are typically at an early stage of development, late-stage investments involve more established businesses that have an ability to take on higher levels of leverage to augment investor returns. While in practice there are multiple approaches to valuation, the approach chosen often comes down to which provides the most accurate representation of the situation and perspectives of the parties involved. This note takes the perspective of a PE investor and assumes some basic familiarity with the structure of PE investing. It provides a basic overview of the primary sources of financing and the metrics used to gauge LBO capital structures and a step-by-step example of an LBO analysis. What is a Leveraged Buyout? A leveraged buyout is simply the purchase of a firm by an outside individual, another firm, or the incumbent management using large amounts of debt to finance the purchase. Most often, LBOs are undertaken by private equity firms that specialize in these transactions (e.g., Blackstone, Carlyle Group, and KKR). PE firms that specialize in LBOs are often referred to as sponsors, because they in effect sponsor or propose the deal. Unlike strategic buyers, who often have assets or expertise to combine with the target firm, sponsors are typically financial buyers whose expertise lies in arranging the financing and incentives for management to perform in a highly leveraged transaction (HLT). That said, sponsors must also have a keen eye to identify opportunities for operating improvements. . . .