Debt capacity and the equity gap

When estimating debt capacity, fleshing out the LBO modelling structure, and determining the equity gap, there are a number of “right” answers.  Here is one answer:

  • Debt = say 5 x 2.0 EBITDA = 10.0.  Depending on the size and the quality of the business, this may represent a stretch for banks.  Banks are going to be attracted to a business that is growing quickly, cash generative and provides them with some degree of asset cover.  If you talked to the managing director about these matters (and perhaps also had some initial conversations with banks) you might be able to get some comfort regarding the debt multiple envisaged here.
  • The institutional equity requirement = say 3.5.  The total equity requirement = say 4.0.  If management put in say 0.5, we would need to go out to private equity institutions for 3.5.

Course explaining the impact of debt capacity on LBO modelling

You can download a spreadsheet showing the LBO modelling structure, and the impact of debt.

The impact of debt capacity on LBO modelling

Now that we have completed the deal structure (including our 3.5 institutional equity requirement) we need to think about the returns available for private equity, whether the business can grow fast enough to support the returns, and whether the whole deal might be realistic.  Only at that point will we be able to help the managing director decide whether the team can afford the valuation envisaged by the deal.

Return to the debt modelling section of the LBO course

Click here to return to the section of the LBO course dealing with modelling debt.  Please click here to continue with the private equity LBO modelling training, or you can find out more about our LBO course.