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Лун Зрфсу > Additional > Flashcards

Additional Flashcards

1
Q

Purpose of different areas of due diligence and responsible parties

A
  • Financial & accounting & tax - buyer / accountants
    To ensure that financial model is right.
  • Commercial & product - buyer / consultants
    To ensure that target has commercial prospects.
  • Fixed assets - buyer / legal
    To get a full picture of owned & leased PPE.
  • IP and technology - legal and consultants
    To ensure that company’s IP is unique & protected and no other IP breached.
  • Contracts & compliance & litigations - legal
    Ensure that contracts properly structured, highlight all change of ownership clauses and ensure that there are no unattended regulatory & litigation risks.
  • HR & Culture - buyer / legal
    Ensure quality of the employee base, culture and avoid employee issues
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2
Q

Commercial & product due diligence

A
  • List of major customers lost in the last 3 years with explanation of the loss
  • Reasons for churn
  • Industry specific KPIs and how those compare to competition (retention etc)
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3
Q

What to look for in a management team

A
  • Experience & knowledge fit for the strategic value creation plan (if buy-and-build then experienced in acquisitions)
  • Hungry for more
  • Cohesive, able to work together
  • Ready to reinvest with the sponsor
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4
Q

Ways PE makes money in LBO

A
  • EBITDA growth (core business growth - top-line growth, cost optimization, general optimization)
  • Multiple growth (business repositioning, market cycles)
  • Debt paydown, cash generation
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5
Q

Attribution Analysis

A
  • EBITDA Growth: (Final EBITDA - Beginning EBITDA)* Purchase Multiple = $
  • Multiple Expansion: (Final Multiple - Entry Multiple) * Final EBITDA = $
  • Debt paydown: (Total Exit Value to Sponsor - Initial Investment) - Value from EBITDA Growth & Multiple Expansion
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6
Q

Threshold of investment grade vs non-investment (leveraged finance)

A

Investment grade S&P, Fitch: BBB, Moody’s: Baa and higher. Non-investment S&P, Fitch BB, Moody’s Ba and lower.

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7
Q

Differentiating competitive advantages to fend off price competition

A
  • Brand
  • Unique resource (IP, assortment, experience, dataset, quality etc)
  • Human resource
  • Premium positioning
  • Vibrant community
  • Additional unique value-add aspects for buyers like availability of broad portfolio of solutions that allows buyers to consolidate vendors
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8
Q

Business risks in PE context

A

Internal (preventable through rules based model) / Strategic / External (managed and mitigated)
- Financial risks
Solvency risk, liquidity risk of potential investment, currency risk, risk of expected synergies not materializing, seasonality
- Operational risks
Underperformance in R&D and sales, How predictable the revenue (Customer concentration, type of customer (SMB vs Gov vs Enterprise), customer loss risk), operational leverage (fixed/variable costs), integration risks
- Market risks
Macro economic risk, industry cyclicality, competition, slow down in growth, obsolescence, growth in cost of inputs, technological and regulatory changes, country risks
- Legal risks
Compliance, litigation, use/loss of IP, fraud
- Other risks
Political, natural disaster

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9
Q

Gross Retention for SaaS business

A

Measures annual revenue lost from a company’s customer base, not including any benefits from expansion revenue (cross-sells, upsells), or price increases (90%+ for healthy SaaS business)
ƒ (Starting Recurring Revenue – downsell – churn)/Starting MRR

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10
Q

Net retention for SaaS

A

Net Revenue Retention (NRR) Rate is the percentage of recurring revenue retained from existing customers in a defined time period, including expansion revenue, downgrades, and cancels. Your NRR percentage is a broad metric that functions as a snapshot of what your company might look like over time if no new customers were acquired. (over 100% for healthy SaaS business)
ƒ Sum(RR (recurring revenue) at the beginning of the period + expansion RR during the period - downgraded RR during the period - cancelled RR during the period) / (RR at the beginning of the period)

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11
Q

Red flags for fraud / scams to look for

A
  • Off the BS liabilities
  • Siphoning off money from the company through capex and other expenses
  • Understating taxable income and associated manipulations
  • Accounting manipulations: D&A, transfer pricing, understating revenues & income; overstating revenues through false entries; capitalizing expenses
  • Moving goods to the channels and recognizing it as revenue
  • Buyback agreements
  • Offshores to hide liabilities, underperforming assets etc
  • Loans to affiliated companies
  • Overstated expenses and cash backs
  • Dilution of ownership stake
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12
Q

Entrepreneur’s concerns working with PE

A
  • What you don’t know. Entrepreneur outgrown collective skillset of the company. Need new skills to grow further
  • The loss of control - but still accountable to employees and clients.
  • Airing dirty laundry. All your deeds current or past will be revealed
  • Outsiders. Letting outsiders in and they might “muddy” the water for you
  • Being accountable to others, getting “a boss”.
  • Vulnerability. Put yourself in a vulnerable position if you underdeliver and investor wants to get rid of you
  • Admit to yourself that you need help. Admit that you’ve taken the company as far as you can on your own and need outside help
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13
Q

Common requests in due diligence

A
  • ## List of top 10-20 clients with contribution to the bottom line for each
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14
Q

Ways to convince entrepreneur to take investment

A

1 step: Establish common vision - make sure you and the entrepreneur are looking at the business and the future the same way
2 step: Make it clear how the partnership will look - how the governance will look, make entrepreneur comfortable that he knows what he is signing up for
3 step: Move to active sale of your investment - show potential value add that you and investment can bring, show how much he can earn as a result, provide references
- Show potential return of their equity if PE assumptions achieved
- Provide clear path to growth and value add that you can provide
- Show how you worked with other portfolio companies
- Provide references from other entrepreneurs

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15
Q

What to ensure in dealing with different stakeholders in a deal like mgmt?

A

Ensure alignment of interest with mgmt in the deal through equity incentives and stake in common success. Even with sellers aim to ensure alignment through earn-outs, escrow account etc.

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16
Q

What is preferred yield in PE returns waterfall? Is it beneficial for mgmt?

A

Preferred stock A that is distributed to every stakeholder who contributed equity to the acquisition (PE fund and mgmt rollover) might include preferred yield (8-10% of guaranteed return on the investment). In this case Stock A might get disproportionate share of returns if ABC waterfall dries down early (not enough returns). If mgmt holds stock B post-acquisition they might choose lower offer price but a structure that doesn’t have preferred yield on stock A.

17
Q

How ABC waterfall functions?

A

First stock A gets initial investment back (and preferred yield if included), then stock B gets returns where mgmt holds for example 10%; if returns exceed certain threshold then stock C gets returns where management holds for example 25%. This way mgmt is incentivized to do a good job.

18
Q

Are mgmt fees charged to the company’s cash flow beneficial for mgmt?

A

No, those decrease company’s cashflows and amounts available for debt repayment or investments and might lower mgmt incentives stock pool. Mgmt might choose an offer with lower price but without mgmt fees.

19
Q

Dilution protection feature in SPA

A

Allows mgmt not to contribute additional cash in case of dilutive event (i.e. issuance of stock to fund M&A) but instead mgmt gets additional stock from incentive pool to keep the same % of company

20
Q

Operating leases VS capex and their affect on EBITDA

A

Operating lease is recognized as opex and therefore lowers EBITDA. But you pay higher taxes. Buying equipment outright allows you to recognize it through capex and increases EBITDA.

21
Q

What to do with EBITDA adjustments if owner of the target company owned real estate and didn’t charge the company any rent?

A

Add all new expenses to lower the EBITDA but at the same time if any expenses stop under the new owner - you can add it back (like personal car expense etc). One-time consultancy expenses will get added back to EBITDA as well (instead of hiring full-time employee that will increase opex).

22
Q

List some of the red flags you would look out for when assessing a potential investment opportunity?

A
  • Cyclicality
  • Customer concentration
  • Customer churn / loss
  • Discrepancy in historical and projected growth
  • Volatility in margins / revenue growth
  • Change in accounting policies, off BS liabilities and other signs of fraud
  • Lack of differentiation and ease of copying company’s products
23
Q

Why valuation can be different for companies in the same industry?

A
  • Return on investments (FCF margins generated)

- Growth rate difference

24
Q

Detailed pitfalls to look out for when analyzing financial statements and a company

A
  • Off balance sheet liabilities
  • Intercompany loans & transactions
  • Bad debt & returns in accounts receivables
  • Offshores
  • Does projected sales growth supported by associated growth in capex & operating assets?
25
Q

How to project operating model for a company?

A
  1. Starting point - historical operating metrics & operating metrics of peer companies (over the long term peer companies will trend to the same level due to competitive pressures)
  2. Modify the typical driver patern for forecasts in the economic and the industry
  3. Forecast how firm’s drivers will be different from typical industry drivers due to it’s strategy and impact of competition
26
Q

Ways to challenge other firms competitively

A
  • Price reductions (Walmart)
  • Product innovations
  • Product delivery innovations (Dell, Amazon)
  • Lower production costs
  • Emulate successful strategies
  • Enter fields that show abnormal profits
27
Q

Ways to counter competitive forces

A
  • Brand creation and maintenance
  • Creating proprietary knowledge that receives patent protection
  • Managing consumer expectations
  • Alliances with suppliers, firms with related technology
  • Exploiting first mover advantages (walmart, google)
  • Creating superior production and marketing (Dell)
  • Staying ahead in technological knowledge and production learning curve (Intel)
  • Creating economies of scale that are difficult to replicate ( telecom)
  • Creating proprietary technology standard or network (Microsoft)
  • Government protection
  • Access to unique resources (data, natural resources, HR)
28
Q

Recourse VS Non-recourse Debt

A

Recourse debt holder can claim other borrower’s assets in addition to the collateral. Non-recourse debt holder only can claim collateral and nothing else even if collateral is not enough to cover outstanding debt balance.

29
Q

Is interest on shareholder notes tax-deductible?

A

If it’s majority shareholder then the interest is not tax-deductible per US GAAP.

30
Q

LIFO / FIFO COGS / Inventory

A

In inflationary environment
LIFO: COGS Higher / Inventory Lower
FIFO: COGS Lower / Inventory Higher

31
Q

Ideal LBO candidate

A
  • Right price
  • High & predictable cash flow
  • Opportunities for creating alpha
  • Clear path to exit
    ~ Strong mgmt
32
Q

INDEX ( MATCH) How work

A

MATCH returns number of specified element in an array. Index returns value under certain number in an array

Лун Зрфсу (15 decks)

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