My name's Ollie. Hello, nice to meet you.

We're going to be having a look at LBO structure, which is quite a loose idea.

Then what we're going to do is we're going to have a look at scenario-based source and uses. And we're going to use this advanced model to explore these ideas, which is HoLogic.

We're then going to have a look at different types of debt and how they're arranged. So fees, OIDs. Okay, we'll leave pro forma until the end.

Okay, then TLBs, public debt, mezzanine, and then towards the end, we'll have a look at the returns, it's kind of like a waterfall, and see who gets what and why they might want to arrange the finance the way they do.

So the session is mostly around financing.

So structure means financing in the context of this webinar.

And the way we're going to do it is we're going to open up this spreadsheet, HoLogic Advanced LBO Full. So we'll not build the model, we'll use the model and modify it to explore ideas. Okay. Which you can do with me or you can just watch me do it.

Okay.

And I've got about an hour. I usually run for about 45 minutes or so.

Then we've got some time for questions at the end if we want.

Okay, so we've got this deal here.

Now let's have a look at the company.

So we've got HoLogic.

So a medical company, women's health.

Okay, so if we have a look, they make these machines, and then they rent these machines to other companies, like healthcare providers.

So they themselves don't use the machines very much.

They build the machines and maintain them, and then lend them out to healthcare providers who do tests on women's health.

And they mainly make their money through consumables, so machines themselves.

So like printers and cartridges. Okay, so this assaying equipment this dude's using, they cost quite a lot of money relative to the machine that you put the assaying equipment in.

If you look ...

So if I go back.

Okay, so if I have a look at the overview, you can see that they're a relatively old company.

Okay, and then if I type in LBO.

Okay, you can see Blackstone and TPG, very recent. So completed April this year.

And so at some point last year, I forget when, I built this model, and I tried to make it as realistic as possible. It's difficult sometimes to get a view inside these deals without specialized data providers that I don't completely have access to, but I tried to do a good job here.

The first fudge I did was I let the completion effectively happen at the end of 2025. Okay? So we know that's not exactly the case, but it just worked well for the year-end.

Now if we take a look through, what we've got here is advanced model.

It does dilution. It's got these financing packages.

Okay. It's got source and uses. It's then got some interesting structure that we'll talk about later in terms of equity stakes. And then as opposed to your intermediate model, it has one, two, three IRRs because there are three equity stakeholders who have different access to upside. But again, we'll talk about later.

We've then got an income statement, a balance sheet, and a cash flow statement, and we've got full-on debt schedules with a waterfall.

So this is like an intermediate model, but with lots of bells and whistles attached to it that we can use to discuss these ideas and develop.

Okay, this is probably much too complicated for most funds when they're trying to figure out a target. Okay. The model that we're looking at now with three statements you might build if you've got very details-driven stakeholders, maybe like ratings agencies, if you're going to issue public debt or something like that.

Now, the first thing we'll do is we'll have a look at these source and uses and try and make a flexible table. You see down here, if I were to reveal the formula for that here ...

But you can see the way it's working is there's an index, and the index is referring to C to D.

Okay, we're up here.

And then it's picking horizontally from D49, which is here.

And that means that if I hit one, you can see those numbers below change to finance package one. And then if we hit two, then we go to two.

Now this is just basic scenario planning, just applied to a source and uses table, but you may not have seen it before.

The normal place that you might see scenario planning is within operational models to create, say, downside cases. Which by the way, we also have over here in the input tab where we can set the model to a bank case or set it to, say, a management case.

Now we're using it here to create a flexible deal structure, and what we could do is, say, do package three, and say in package three, let's just copy the basics first and let's play around with it, let's say we go very low debt.

You can see that would have to be an enormous number of profs, and that would do things to the deal. If we wanted to then create that as a package that could be picked from down here, we would have to work on validation.

Now I usually do search these days, Alt Q, start typing in validation, and then we'd have to make sure that option three is possible.

We'd then need to make sure that each of these has a third option to pick from.

So if I F2 that ...

Can you see? I think I've done something funny there. All right.

Anyway, I'll leave it alone. If I F2 that, you can see that the array is only two wide, so that needs to be spread to three.

And now if I copy down, nothing seems to happen. Now if I pick three ...

Okay.

That's interesting.

Okay, so clearly when I put my restrictions in, I did something wrong.

That's interesting. It didn't take.

So I'm not sure why that was the case. Maybe I didn't press okay. I'll do it again.

So now if I put three, then I get my third package.

And that's quite a simple way of doing things.

But it creates a lot of really strong analysis because we could now attach a data table to that number, create a data table with one, two, three along here.

Okay. And then we could see what the sensitivity to the package would be without having to toggle over and over again.

So if I were to do that down here, if I pinch these and then pinch these.

If I do one, that needs to be a number.

Two and three.

And then if I say, well, what is the fund IRR? Then what I could do is I could hit Alt VT, and the row input cell now, what I could do is I could give it control over the financing packages, and then secondly, give it control over the exit because that's the exit model.

And now I can hit okay, and I can say, okay, and I'm going to hit nine to make it work.

Turn these into percents.

And I might just create a bit of a narrative and say this is traditional.

Okay, this is the alternative debt, and this is de-levered or something like that.

You can see that de-levering the deal is pretty catastrophic for the IRR, which makes sense because it's supposed to be a leveraged buyout.

And it's very helpful for creating scenarios for your financing packages and then presenting those very nicely on slides.

Okay, so that's scenario planning on sources and uses, which relies on you being in control of, say, index or offset or choose, then being able to plug that into a table like this and explore eventualities.

Let me just see what's next. So we've done source and uses, and we've done a flexible deal table, so we've got scenario planning going.

We're now going to do OID and fees.

Okay, now let's say we add a fee. And this is actually pretty intense, so if you're doing this with me, tell me if you want me to slow down.

Okay, let's say there's a fee and there's a fee on the TLB, which rhymes. Hooray.

Okay. And I'll just pinch the formatting from there.

Let's say there's, like, a one cent fee.

And I don't actually know what the going rate is on fees on TLBs.

So if you know, let me know. All right.

Now, that fee, you could see it as a fee, or if it were on something like public debt, which we might turn the subordinated debt into public debt, it could be an OID, as it's called.

Okay, now these are different things, but I think functionally a lot of the time we treat them the same.

Now, if we calculate the fee as not percent but as a dollar amount.

Okay, now let's say I put my...

Yeah, let's put two enters there as well.

You can see we've got $50 million of fee on the TLB, and we've got $20 million of fee on the subordinated debt. Now, if I were to zoom in on the TLB and just talk that through.

Okay, so we've got TLB and we've got debt and we've got five thousand.

Let's say we've got a fee of 50. Okay.

What's going to happen is that's effectively going to be a negative, right? So either you hand that over, okay, from the amount that you raised, or you actually raise less than you are going to repay.

Now, a fee, you would normally hand the money over, but functionally, given that you're going to pay the fee to the counterparty that's lending to you anyway, you may as well just treat this as borrowing four nine fifty at time zero, and then maybe at time seven you have to repay five thousand.

Okay, and this is the logic of an OID, an original issue discount.

So public debt often gets kind of issued at a spread or a fee, and it's going to often be driven by tax purposes. Okay, so the counterparty might want capital gain instead of income tax, and so they'll want the gain on the principal rather than the equivalent kind of fee or income through their interest and so their income tax.

Now, this is actually going to be surprisingly complex.

Okay. If I turn that into a five-year TLB just because the numbers are easier on my mind. Right.

I think that puts it over there. Let's just check.

What's going to happen is fees that have no lifetime, it's a funny concept, okay, they tend to get written off against the P&L and against equity.

So if you have a look at the model as it stands, can you see we have fees over here which are driven by these fees as a percentage of EV, and these are probably advisory or transaction fees.

Now these fees don't exactly have a lifetime because they're not tacked to a liability like a loan, which has a fixed life like that five years.

So if we track these, the way the model deals with them, if I alt MD, we have to pay them, so we have to find the finance from somewhere.

And if I track them, you can see they're actually going into the equity as a negative, as a deal effect.

What that means is that they're hitting the P&L, like, immediately, and they're being written off against the equity.

Now this is because these fees, they're like an unknown lifetime fee.

So if we have unknown lifetime fees like advisory fees, transaction fees, we'll write them off immediately.

Now why am I explaining that? It's because when we have fees that have a fixed lifetime attached to them, like debt issuance fees, and what will happen is you'll actually capitalize them and then amortize them over time.

Okay? So you'll end up with the fees being amortized to the P&L slowly, and then you'll find the balance sheet amount rises towards the overall liability that you actually have to repay. And this is complex, and from a modeling point of view, it requires special care.

Now if you have a look at the fee of 50 million.

Now let's say I get rid of the other fee just because it works for me now.

Okay, let's keep an eye on the IRR. So it's 19.5 now.

If I get rid of it, okay, you can see it's gone up a little bit.

These are not the biggest amounts that we're talking about.

And so you'll often find that models will sidestep this issue entirely.

But if you want a really high accuracy model, you'll have to build it in.

Okay, which we'll do now.

All right, so we're actually going to stop beating around the bush and stop talking about it and actually do it. All right.

So if I say term, and let's say I put seven years in, and I'm going to abandon the idea of doing the other fee in the interest of time.

So I'll just do my TLB fee, okay.

Now what we can do then is fee per year, and what we can do is divide by seven, and you can see we're going to get 7.1 per year, and that will amortize the fee and make sure it gets slowly released into the P&L.

Okay, now we've got all of the building blocks to perform the fees.

What we now have to do is build it into our model, which is quite complex.

So if we go left to right, you can see the fee, that's $50.

That really will be paid today.

Okay, so what we'll need to do is we'll need to insert a line here and say debt fees, and we'll have to go and fetch those debt fees, and they need to be paid for.

Okay, that really is cash today. So the amortization is not cash interaction, to be clear. So that's a debt fee paid today.

So that means you've got to find money to drive those, and actually that can create some problems with circularity in certain models.

Right. If I look at the balance sheet, you can see we've got an imbalanced balance sheet now, and that's because we have issued more equity and there's no corresponding value that's being added to the balance sheet.

So what we've got to do now is figure out effectively a more complicated and flexible version of this little working.

So we'll have to say fees, opening, amortization, closing.

Okay. At the point of the deal, which is kind of combo, we would start with the fees that we calculated.

And I keep on using my mouse today. Somebody should probably tell me off about that.

Okay, that'll re-derive next time.

And then what's going to happen is we're going to end up with amortization of those fees as calculated here, and they'll chip away at the debt fee.

Okay, now I think that's ended up going through the bottom, so I've got to be careful here.

All right, and then one way to deal with that is I could bake a min in and then say you can't end up going lower than the opening, which is a classic way of creating a floor Okay, so we've just worked out the amortization and we've now got all the equipment we need to then fill in the P&L and the balance sheet.

Okay.

Now if I have a look, first things first, I'll probably end up putting the fees and the interest expense.

Okay, so I'll probably end up putting the fees and the interest expense.

Let's try it, and if it doesn't work, then we can always change our mind on that.

So I'm going to add, because they are a negative, and so the fee amortization will genuinely hit the income expense or the income statement.

You can see that actually this is quite interesting.

Our balance sheet is now kind of doing something quite expected because there's a gap in our balance sheet which is equal to the closing OID or fee.

So our last job would be, and this is probably the freakiest one, we'll say TLB fee or OID. It's probably more like fee.

Okay. And then we'll say, right, we're going to end up with this fee.

And this is the bit that people generally have trouble with.

This is going to be a negative liability.

It's one of the very few negative liabilities we'll see.

The thing is, most companies or entities would net those two out in their financial statements, so most debt that you're seeing in financial statements is actually presented on a net-off-fee basis, which can be a little misleading.

Okay, you can see the balance sheet balances, and that's partly because the cash flow statement in this model is not picking up the fees here, I don't think. Okay.

And so it's not creating imbalance that way, which is lucky for me.

All right, and that's fees. And you can see that they're surprisingly complex, I'd say. And then given their relatively small size, don't be surprised if you find that models just sidestep them entirely.

Okay.

If you want to see an example of a fee on real statements, or excuse me, balance sheets, let me know. We can have a look at them in a real 10-K or something, if that's helpful. People often have trouble with this, and it is important to understand fees because they come back in more complexity models.

Okay. Have you got it as a negative in your balance sheet, and is it being picked up by the total? Because if you, say, add it at the bottom, the total might not pick it up.

Yeah, it's negative, and it's also in the total. Okay. And in the income statement, have you ended up adding the fee to the interest expense? Let me see.

No, I didn't. Okay. Yep, that'll be it.

So make sure to add the fee because it's negative, and then what that'll do is it'll affect your equity, and it'll pull things into alignment again, hopefully.

And what are we adding? Are we adding the projected closing- The amortization.

Oh, the amort starting in September of three months. That's right.

Yeah, because we're going to see that effectively as extra interest cost from a P&L point of view.

Okay.

Oh, go on, sorry. I was just going to say, it is balancing except for in the out years. Like everyone on year onward.

It's possible that you haven't limited and so you're charging an OID when there's nothing left to charge against.

Can you see you need to make it stop in year seven or, sorry, year eight because we had a seven-year relationship.

Yeah, I did that, so that's weird that it's not.

Okay. Don't worry too much. Okay. You've got the idea, right? And you understand what the OID and what the fee do and why we want to do them right.

Okay, perfect. Thank you. All right.

I think fees are very important because although they're not significant, complicated deal models will model them properly, and they can be a bit of a system shock if you're not used to them.

Okay. So if you're typing, keep typing. Now, where are we going next? We're going to have a look at term loans versus bond issues, so private versus public debt, and this will be mainly talking.

All right, so if we go back to source and uses, can you see that some of these deals are very reliant on what you could call bank debt or institutional debt, is another way you could say it. And some of them are more reliant on mezzanine, and some of them, or all of them, have subordinated debt.

Now, if you look at the way that they behave, you can see the TLB is relatively cheap.

It's priced off SOFR, okay, which is standard overnight lending rate between banks.

This creates protection for the lender because if the interest rate goes up, okay, the overall interest rate SOFR, or like prime rate or base rate or something, then this TLB will start charging more.

The TLB is also relatively short term, maybe seven years.

It might also have a sweep baked into it.

So if you look at the TLB, you can see that available cash flows are being swept into.

Now, this will be negotiable and established upfront, and you might find that not all of the cash gets swept into it. The TLB might have some sort of sweep facility, which is dependent on the gearing or leverage of the target.

But regardless, either way, this debt has a number of mechanisms to de-risk it early.

This means the TLB generally runs at a lower rate.

This is LBO, so it's still relatively high compared to regular term loans.

Now, if we wanted the subordinated debt to be more like a high-yield loan, or sorry, bond, excuse me, then one thing we would have to change is it couldn't really be running off a spread unless it was variable rate public debt, which is relatively rare.

So what we'd normally find is the public debt, what you're being called fixed income, it would run off a fixed rate, and it wouldn't have a spread above SOFR unless it was variable bond, which are relatively rare.

Okay, now because it's fixed, it means that for the lender, there's no protection against interest rates.

If interest rates go up, they don't get the higher interest rate like the TLB would. They're stuck with their 10%.

Now, this means they're going to charge a bit more on the way in.

Okay. And I'm just going to dig out another little list that I've got, which I should have had open already. Apologies.

Just lost it. We're going to go restart.

Okay, it's just opening up. It'll take its time, I'm sure.

There we go.

Oop.

Okay, so some other talking points about bond issues then So on the whole, private credit, uni tranche, and the private credit phenomenon have displaced high-yield bonds to a certain extent in P.

Okay? High-yield bonds are actually quite hard to arrange.

You need ratings.

There's a lot of admin around marketing it and getting your admin right and filings, SEC filings, that kind of thing.

So it's relatively slow compared to private credit.

Okay? It could be more expensive because of that fixed rate.

It could be more expensive than your average term loan because of no sweeps and things. But on the whole, these things would probably be shared by private credit. The reason I think private credit has displaced high-yield bonds is because of that convenience factor. Okay? Admin, ratings, and speed.

Okay, so we won't see public debt so much in source and uses tables.

Where you might see them is where you, as a fund, need to access a really deep capital pool.

Okay? So if we relate that to our deal here, now this is a big deal, but not a kind of ultra deal.

So the debt package, it appears to be something like eight billion or so.

Eight billion's a lot of money.

Okay? And this deal took place in America, where there are very deep capital markets anyway. But let's say this deal were taking place in another place with more shallow capital markets, then you might find that institutional TLB investors and even private credit just can't cut it to provide the debt that's needed to create the leverage. In which case, you run out of runway for the TLBs, and there might not be access to mezzanine. So you might be forced to go to public markets to get the remainder of the leverage that you need.

So the kind of classic situation around public debt versus private is that like in the old days, public was for mega deals.

I think private credit is more and more getting into mega deals, but that was a kind of classic role.

Okay, so that's effectively public debt. You might ask...

Okay, so we've done public debt. Now let's have a look at mezzanine.

So normally, mezzanine would be provided by mezzanine funds, private credit funds. Okay? That's the old style.

And normally you wouldn't see public debt and mezzanine.

It'd be like an either/or situation, or that's the way it used to be.

So mezzanine would be for smaller deals that couldn't access public markets, and then if you could access public markets, you'd go for high-yield bonds. Now these days, I think what you more commonly see, okay, so if I put together a financing package.

Okay? What you'd more commonly see is something like a uni tranche.

Okay? And what the uni tranche would do is it would do the job of all of these and say, "Right, we're going to take a 10 billion." I mean, that's a big one, but a huge uni tranche. And then within that uni tranche, you'd have your kind of term loan tranches, which would be low risk and low yield, and then you'd have your more mezzanine tranches, which would be high risk and high yield.

And what would be presented to the borrower would be more like a blended rate of the TLB and the mez. So you might find that you get a blended rate of like 9% or something, depending on what the balance is internally.

But the borrower of a uni tranche, if we're going uni tranche, would usually not be aware that there's something like a mezzanine within it. Okay? So I'll unwind all that because that was mainly a teaching thing.

But just be aware that the idea of having a mezzanine fund providing mezzanine debt is less popular these days because the mezzanine-style debt is often contained within a uni tranche structure that is being extended by private credit or other players.

Okay, now that's the context around it. Now let's actually talk about mezzanine.

Now, if we take a look at mezzanine, we could see this as like deeply subordinated or there's lots of other labels. Now, the mezzanine is running at a very high rate because it's usually going to run at PIK, so they'll get no return until the end.

It's extremely high risk. It's usually very long maturity, like 10 years or something, and so the lender has kind of everything stacked against them in terms of safety. So what the lender's going to do is charge quite a high initial rate anyway, and then what they're going to do usually is put some warrants in place.

Now, there's loads of jargon around this, but you might see it called an equity sweetener-- sorry, a debt sweetener.

And what this does is it creates upside for the mezzanine holders, okay, who also have downside protection because this stuff is still legally debt.

All right, so the mezzanine, what it tries to do is create something between debt and equity in terms of its behavior.

And that's the context. What we're going to do to finish up is simulate exits for the three types, and that'll help us to understand the return profiles.

Just pausing to see if you have questions.

Again, hello, Santos. I didn't know you were there.

Just open up your mic if you want to talk to me.

All right, now we can see under the original terms of the deal, the fund is going to make 19, mez is going to make about 18, not far behind, and management's going to make 28. But that only really tells a little bit of the story, and we can't really see what's going on there.

So what I'd like to do is create a second data table on top of this data table.

I'm going to make some space here.

And what I'm going to do is I'm going to have the data table be the fund, mez, and management, and I'm going to go and fetch their three IRRs. So there's fund.

Okay, there's the mez, and there's management. I'm going to make those into percents.

Okay, and then what I want to do next is I'll just pinch these.

I want to create a view of like a bad exit.

So can you see this keeps on getting worse and worse? Okay, so given that we got in at 16.9, a nine-turn exit, not going to look too far there, but a 10-turn exit would be a pretty bad exit.

All right, what I'm going to do now is I'm going to create a data table, and you may have never seen this before. Normally, I would highlight like that, and it would interpret it as two variables.

If I highlight like this, it's going to interpret it as one variable and three outputs.

I'm going to hit Alt D-T, so data table.

And now what I'm going to do is the row input doesn't exist because these are outputs.

The column input is the exit multiple.

So I'll go and find that Hit okay. Hope for the best. It often go wrong.

F9. There we go. Let's get some sense going.

All right. Nice. And what we've just created is almost like a returns waterfall you could call it, and it's the sort of thing that you'd be creating in early stage investing where you've got all of these different investors like the As, the Cs, the Bs, that kind of thing. Okay. All these rounds.

Now we're not doing that exactly now.

We're creating different stakeholders and simulating good and bad exits.

All right. Now let's take our time with it.

If you notice, management is the most variable.

So let's just make this clear again.

So that's the original.

So management really does very well if things go well, but does extremely badly if things go badly.

Now mezzanine is kind of in the middle.

If things go well, it doesn't go that well, and if things go badly, it really doesn't go that badly at all.

And then the fund is somewhere between mezzanine and management.

So if it goes badly, they do quite badly, and if it goes well, they do quite well.

So you could see this as variable, you could see this as quite protected, and you could see this as somewhat protected.

All right. Let's play around with the numbers a little bit.

So can you see this is starting at 16.9? If I start at 14.9 instead, and I'm going to go up to the original, which would be more or less the original.

And then what happens is as I go down, you can see something emerging.

Management have no protection.

That means when the exit's bad, they feel it.

The fund has some protection.

That means that management takes a hit first before the fund starts to see losses.

Okay. Can you see the management need to be completely gone effectively before the fund really starts to see losses? The mezzanine has the highest protection.

They never see genuine losses, but in a way they are creating losses that we'll discuss in a minute.

Right. The reason we're seeing this is because of the exposure to equity.

Now what the fund has done is they've concentrated a lot of risk in management, and that's because management simply put the role in and get the exit out.

And that means a bad exit will hit them hard, whereas a good exit will put a lot of money in their pockets. So very variable.

If we now jump to the fund, you can see the fund is very exposed to equity, but because they've chosen to put a bunch of preference shares in which effectively act as PIK debt to a certain degree.

Okay. What's going to happen is a bad exit will hurt them in their equity pockets, okay, but all of their equity needs to be gone and all of management's equity needs to be gone before the pref start getting hurt.

Now mezzanine has the best downside protection.

Okay. For starters, it puts no money in for the equity.

So losing on the equity doesn't actually create a loss. It's just a lost gain.

Okay. Because the warrant is free.

Then the mezzanine debt, can you see that that mezzanine debt will always achieve its output as long as there's any kind of life in this deal? And that's because it's debt, which has quite a lot of legal protection.

So the mezz is running at 12% and it's actually quite difficult for the deal to result in less than 12% return.

You can see that the deal would have to be so bad on the way out that all of the other equity holders are wiped out effectively as a cushion.

It's your classic liquidation stack, right? We're almost getting into the world of liquidation here.

This would be like a fire sale kind of situation.

And so what we're looking at here is a kind of waterfall.

What we're also looking at is a common behavioral strategy of funds.

Because what the fund can say to management is, "Look, you are the most exposed here. So if you do well, you do very well, better than me actually.

And if you do badly, you do very badly and I will not suffer as badly.

So you better not do any silly stuff like take too much risk and you better work really hard because you're in the running for a lot of output." So when funds take on preference shares, and in my model we've got a lot of preference shares here, what they're doing is concentrating risk in the management tranche.

It's also perhaps got some tax benefits in many cases.

Preference shares can be used for financial engineering purposes as well in deal structures.

Okay. So in terms of what's missing from this, I think, look, within the fund, okay, this PE institution, we've now not really disaggregated the LPs and GPs.

This would be many points at the LPs.

If we were going to do a full model, we'd also want the kind of returns waterfall with the fee and the carry and stuff for the GPs, which is a little invisible from this model. Okay. That would be part of that waterfall with hurdles and all sorts.

Okay. So where are we? So yeah, we're going to wind down now.

In terms of follow-on work, if you want to go a bit further, you could go to Felix, investment banking, private equity.

If you wanted to learn how to build a heavy model like that, you can build Debenhams model here.

If you wanted to learn about the debt types, you could have a look here.

Okay. If you wanted to learn more about the returns waterfall that I mentioned at the end, you could look here.

Okay. And then if you want to see how a management role works in more detail, you could have a look here. All right. It's 10 to. That's the end of the webinar. Hopefully it was helpful. Have a nice afternoon, evening, morning, wherever you are. And hope the weekend's very nice for you. Feel free to stick around and ask questions.

We'll go now. It's up to you. And yeah, have a nice rest of the day.

And thanks again. Thanks for the contributions.

Always makes it more fun.