In our final lesson and to keep things a little bit interesting, I thought it would be instructive to put together all that you've learned in this course by presenting a case study. And in this lesson, we're going to see a company grapple with establishing a finance strategy to execute a management buyout. Let's get started. leveraged buyouts are situations when an acquirer layers on additional sources of debt financing to the acquire business in order to pay for the purchase price. Now the goal is to achieve one of sustainable balance. On the one hand, we need enough sources of financing to pay for the acquisition costs.

On the other hand, we need to ensure that the business has sufficient cash flow to meet the financing requirements of the debt facilities. So welcome to Greenland company. It's a company that sells Arctic glaciers to consumers. looking for alternative cooling solutions. A group of senior managers has negotiated to buy all of the outstanding shares of Greenland company from the current shareholders for $87 million. With $13 million of existing debt outstanding, the enterprise value of this company is $100 million.

Our job is to establish the financing strategy. And the questions we need to answer are, first of all, do we have enough sources of financing? And secondly, will the cash generated from the business support the debt load? And thirdly, have we minimized our cost of capital? Now from the statements that you see on the screen in front of you, there's a couple of key numbers that you're going to see recur throughout this lesson. Notice first of all that our eba is 19 and a half million dollars.

Also, the total book value of the assets is about eight million dollars. So in essence, we are paying a premium which implies that there is some goodwill inherent in this transaction. Also note the existing debt on the line of credit of $13 million. So this can either be assumed or replaced with a new facility, you can pause the video and familiarize yourself with the other numbers. Now in discussion with various providers of capital, you're going to arrange different potential sources of financing. This is typically done through what your advisors will call the roadshow, the management team has made a commitment and they have available to them $3 million of their own money.

And next you're going to approach the bank and just to determine the size of the credit line that they'll offer as well as any term loans that they may provide for the capital assets. So the line is based on a margining of 75% for receivables and 50%. For the inventory. The term loan has been On a 40% LTV loan to value of the capital assets. And both of these facilities are going to bear interest at 7%. The bank has specified a maximum EBITDA coverage ratio of two times.

The exiting shareholder has indicated to us that he's willing to defer up to $5 million of the consideration, but he's going to charge us 6% interest on this note, this is commonly referred to as a vendor take back and next week approach a mezzanine financing fund. And they say that they'll provide another two turns of trailing 12 eba. With an overall debt leverage level of no more a maximum of four turns of EBITDA. The facility is structured as a seven year term loan and a 16% coupon rate. Finally, we've identified Potential private equity partner who's willing to invest up to $20 million on the same basis as management. So we need to do a bit of math now to figure out if we have sufficient sources of financing to close the transaction.

With all those various sources of financing now identified. Let's go through and see if we can answer the questions. Now starting with the cheapest sources of financing First, the vendor take back is the first piece of financing that we feature in our new capitalization structure. The bank financing is the next cheapest and they're willing to give us an operating facility. Based on the working capital of the assets. We can do a few calculations and determine that there's a maximum available of $25 million.

Based on the security we have. The existing line has $13 million outstanding, leaving potentially another $12 million in excess capacity that could be used to close the transaction. Also with the bank, the capital assets represent another potential borrowing base of $14 million. So combined, the $14 million, and the $25 million on our line of credit represent $39 million of senior secured lending. When we do the calculation, you realize that this as at the top end of the maximum amount of debt leverage that the bank is willing to assume at two times. The vendor take back and the bank finance still leave us considerably short though, of our purchase price.

So we need to move further into our sources of financing. Next, we take a look at the mezzanine funds from mZ funds. The amount of mezzanine financing is available is also $39 million because it represents Another two turns of EBITDA. And having exhausted all of our potential sources of debt financing, we have no choice but to fund the balance of the purchase price. With sources of equity, we know management's in for $3 million, leaving a gap of $14 million that needs to be raised. In this case, we have identified a suitable private equity partner who will provide the balance of funds.

So we're now left with a capitalization table that shows this balancing of our sources of funds with our transaction price, and we can conclude that we have sufficient sources of financing to close the deal. Another way of representing the sources of funds is represented here. However, we have yet to answer this really important question about whether the business can sustain this level of debt financing And for that, we will need to prepare future cash flow. Now our future cash flow schedules the cash inflows and outflows to determine if there's sufficient cash flow to service all the sources of financing, revenues and expenses are projected over the forecast period. And you should at least consider the term of the senior debt in terms of setting your forecast period. We also need to factor in other things such as the interest cost and principal repayments.

And of course, don't forget the taxes. This can make a huge difference in our analysis. Next, we need to factor in the capital expenditures. free cash flow is the amount of cash available for the shareholders to allocate at their discretion. Positive free cash flow implies that we have a viable plan. However, notice that our free cash flow is just barely positive, just enough to cover the debt service costs in the earlier years.

This implies that any underperformance will require additional sources of financing. Our financial professional can look at an analysis such as this, and and critically evaluate whether it's realistic and achievable. Time for you to play along. I want you to review this future cash flow and add your insight. Pause the video for just a moment and see if you can identify other areas of potential opportunities or challenges. I'll be back in a second.

Okay, what did you discover? If I were reviewing this analysis? Some of the areas that management should consider further in this financing plan would include one working capital, yes, growing revenue without an incremental investment in working capital is not likely realistic. Many people seem to forget the working capital requires an incremental amount of financing until it's too late and you're left scrambling to pay the bills. Next, take a look at the Capitol expenditures. These need to be sufficient to not only maintain the existing business, but also to fund the growth projected in the business plan.

In this case, we have our sales growing by nearly 50% over the next five years, and without any incremental investment in our plant, is this realistic. Next, consider whether management has a risk management plan in place to deal with economic or industry volatility, it's highly unlikely that these results will actually achieve a nice smooth upward trajectory. And so we should conduct some sensitivity analysis and line up additional sources of financing in the event that the plan fails to materialize as projected. One way to do this is to perhaps preserve some flexibility on the line of credit by using perhaps more of the private equity investment money to fund the purchase price. Next, consider whether management has considered any tax planning opportunities to minimize the cash taxes payable. And finally, the board should align and set performance incentive plans with the business plan and the cash flow needs of the business.

It may be advantageous to use a an option based incentive over a cash based incentive to preserve cash for the business. So don't necessarily accept what has been given to you as gospel and always challenge the information to think through all of the different possible outcomes. Before we go. Let's just take a look at what the expected return for the equity holders are if the management team is able to execute the business plan and sell Greenland for say the same multiple in five years time only executing the business plan. Today's even up 19 and a half should grow to $29.1 million in five years. At which point it was would be sold to say a strategic buyer or taken public to raise funds of 100 and $8 million.

Under these assumptions, the equity holders would earn a 53% return on their investment. This would include both the management team and the private equity group partners. So in this lesson, we got to work through the preparation of a financing plan, we got to see how capital got layered up by taking into consideration the availability, the amount and the cost of the various sources of financing. We also looked at the preparation of future cash flow, which validate that we have sufficient cash flow to meet the debt service obligations. And finally, we got to see how the Private Equity Partners and their capital alongside the strong management team will realize their equity returns. That's all for this course.

Folks, thanks so much for dialing in and we'll see you next time.