How do we model an add-on acquisition in an LBO? First, we take a base case, LBO model. This can sometimes be called the platform or the underlying portfolio. It is a normal LBO model. It needs model inputs such as the purchase price sources and uses of funds, interest rates, tax rates, sales growth, et cetera. Then we build the forecast model. This needs everything important for LBO models, I.e. cash flows from running the business. Then debt pay down and finally onto model outputs such as the IRR, internal rate of return or money multiples. Everything so far gives us the base case, LBO model.

Next we move on to the add-on and we need information about the add-on company. This is similar to the inputs for the base case LBO, so things like purchase price sources and uses of funds, sales growth, tax rates, et cetera. This will give us the basic forecast model cash flows. We could then calculate debt pay down and the IRR of the add-on, on its own, but we don't, we're not buying the add-on company to be on its own. We're buying the add-on to bolt it to the base case company, so no outputs for the add-on yet.

Then third, we merge the base case and the add-on together. We need to do a new income statement and new cash flows. Then we calculate the combined debt pay down and ultimately the cash flows available for equity holders. This will finally give us a new updated set of outputs, i.e., the new IRR and or money multiple of the combined businesses.