Ownership and Goodwill
- 05:20
LBO modeling complexities ownership and goodwill
Transcript
We now have to calculate the ownership stake in the transaction, both at entry and at exit. And we need to calculate also the goodwill. First, for the ownership. The ownership here that we're talking about is the ownership of the common equity in the company. If we go back up to the sources and uses table, we see that we have two types of equity. We have a preferred equity and we have a common equity. The preferred equity is really kind of a hybrid between a loan or shareholder note and an equity security that has a capped return. And that it's got a coupon of 12%. So for the management to participate in upside beyond that 12%, it needs to have a stake in the common equity, the residual ownership of the company, 'cause that's the only way for the sponsor to actually get beyond this 12% and achieve a return that's more in line with the kinds of returns that private equity is looking to make in these transactions. So that's the first reason why there needs to be common equity in the deal and why the sponsor has to have some stake in the common equity. The other reason has to do with the fact that if we look at what's happening here, initially, the common equity is being split between the management and the financial sponsor. So the sponsor's equity is going to be 90%, and management's gonna be 10%. The management stake is the rollover from the previous transaction. So management has been asked to stay on and be a part of this new entity and to help guide it more in greater success. And they're going to be incentivized. So to get what they call skin in the game, management is being asked to put money into this transaction so that they're at the same table as private equity, and they're going to be compensated with additional equity on exit. So for the sponsor to be able to award additional equity to management, or in this case, also to Mezzanine who's getting rewarded with equity on exit, private equity has to have shares in that common equity to be able to transfer ownership. So at entry, we see only the sponsor and the management team. Mezzanine is lending capital at this point, but at exit, what's going to happen is Mezzanine is going to be rewarded with warrants that enable them to transfer that loan into ownership, and that ownership will give them up to 5% of the company. So in this particular situation, that dilution that comes from Mezzanine getting 5% is going to come out of both the private equities' share and the management share. Now, that's typically not how it works. Management is going to have options that are going to vest over time that are gonna be to be performance based. And their ownership at exit is actually going to grow. In this case, and in maybe just this particular deal, this deal is from a number of years back. What's happening here is the sponsor and management are going to share the dilution to bring the Mezzanine into the deal. And that may just have been what it took to get Mezzanine to come into this deal. We won't know until we actually look at the returns. Typically, Mezzanine, more recent markets is trying to drive their returns from their coupon of, in this case, 12% up 150 to 200 basis points on top of that. They're not looking to be long-term owners in this business. So again, until we get to the returns, we won't really be able to see what's going on here. But for now, we're gonna share this dilution at exit between the sponsor and the equity. So the sponsor is going to get one minus the 5% times its prorata initial ownership stake of 90%. And the management, we could back into it simply by backing out of a hundred. But I will do the calculation anyway, is going to get its prorata stake of 10% post-Mezzanine dilution. And that's gonna bring us to the appropriate 100% on each side. Now, we'll move over and calculate the goodwill. The equity purchase price for this transaction, we have from above in our sources and uses table, that is the 1487.1. And in terms of the net identifiable assets or the tangible net assets that are being purchased, that's gonna be net asset value, less any existing goodwill, existing goodwill from previous transactions. So we're gonna have to go over to our balance sheet and see what's on there. And if we look at what's on this balance sheet, we see that they have no existing goodwill. So this calculation will be pretty straightforward. It's gonna be equal to the net asset value, which in this case is the equity, less any goodwill, which is zero. If we net these two, that tells us what our transaction goodwill is going to be. And that's 633.8.