The notion of “spreading” refers to performing calculations in a spreadsheet program such as Microsoft Excel.

The Securities and Exchange Commission (SEC) is a federal agency created by the Securities Exchange Act of 1934 that regulates the U.S. securities industry. SEC filings can be located online at www.sec.gov.

The sum of the prior four quarters of a company’s financial performance, also known as trailing twelve months (TTM).

Public or publicly traded companies refer to those listed on a public stock exchange where their shares can be traded. Public filers (“public registrants”), however, may include privately held companies that are issuers of public debt securities and, therefore, subject to SEC disclosure requirements.

Presentations at investment conferences or regular performance reports, typically posted on a company’s corporate website. Investor presentations may also be released for significant M&A events or as part of Regulation FD requirements. They are typically posted on the company’s corporate website under “Investor Relations” and filed in an 8-K.

A process through which a target is marketed to prospective buyers, typically run by an investment banking firm. See Chapter 6: M&A Sale Process for additional information.

Other factors, such as the local capital markets conditions, including volume, liquidity, transparency, shareholder base, and investor perceptions, as well as political risk, also contribute to these disparities.

Depending on the sector, profitability may be measured on a per unit basis (e.g., per ton or pound).

Net operating profit after taxes, also known as tax-effected EBIT or earnings before interest after taxes (EBIAT).

A company’s annual proxy statement typically provides a suggested peer group of companies that is used for benchmarking purposes.

An initiating coverage equity research report refers to the first report published by an equity research analyst beginning coverage on a particular company. This report often provides a comprehensive business description, sector analysis, and commentary.

A solicitation of shareholder votes in a business combination initially filed under SEC Form PREM14A (preliminary merger proxy statement) and then DEFM14A (definitive merger proxy statement).

Not all companies are LBO candidates. See Chapter 4: Leveraged Buyouts for an overview of the characteristics of strong LBO candidates.

Standard Industrial Classification (SIC) is a system established by the U.S. government for classifying the major business operations of a company with a numeric code. Some bankers use the newer North American Industry Classification System (NAICS) codes in lieu of SIC codes. The SEC, however, still uses SIC codes.

First Call and Institutional Brokers’ Estimate System (IBES) provide consensus analyst estimates for thousands of publicly traded companies. Both First Call and IBES are owned by Thomson Reuters.

The Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system performs automated collection, validation, indexing, acceptance, and forwarding of submissions by companies and others who are required to file forms with the SEC.

The deadline for the filing of the 10-K ranges from 60 to 90 days after the end of a company’s fiscal year depending on the size of its public float.

A section in a company’s 10-K and 10-Q that provides a discussion and analysis of the prior reporting period’s financial performance. It also contains forward-looking information about the possible future effects of known and unknown events, conditions, and trends.

The financial statements in a 10-K are audited and certified by a Certified Public Accountant (CPA) to meet the requirements of the SEC.

The deadline for the filing of the 10-Q ranges from 40 to 45 days after the end of a company’s fiscal quarter depending on the size of its public float. The 10-K, instead of the 10-Q, is filed after the end of a company’s fiscal fourth quarter.

The financial statements in a company’s 10-Q are reviewed by a CPA, but not audited.

Depending on the particular triggering event, the 8-K is typically filed within four business days after occurrence.

The legal contract between a buyer and seller detailing the terms and conditions of an M&A transaction. See Chapter 6: M&A Sale Process for additional information.

Regulation FD (Fair Disclosure) provides that when a public filer discloses material non-public information to certain persons, as defined by the SEC, it must make public disclosure of that information typically through the filing of an 8-K.

Once a given consensus estimates source is selected, it is important to screen individual estimates for obsolescent data and outliers. For example, if a company has recently made a transformative acquisition, some analysts may have revised their estimates accordingly, while others may have not. Bloomberg and other sources allow the banker to view individual estimates (and the date when they were posted), which allows for the identification and removal of inconsistent estimates as appropriate.

Access to these websites requires a subscription.

For modeling/data entry purposes, manual inputs are typically formatted in blue font, while formula cells (calculations) are in black font (electronic versions of our models are available on our website, www.wiley.com/go/investmentbanking). In this book, we use darker shading to denote manual input cells.

This template should be adjusted as appropriate in accordance with the specific company /sector (see Exhibit 1.33).

Stock options are granted to employees as a form of non-cash compensation. They provide the right to buy (call) shares of the company’s common stock at a set price (“exercise” or “strike” price) during a given time period. Employee stock options are subject to vesting periods that restrict the number of shares available for exercise according to a set schedule. They become eligible to be converted into shares of common stock once their vesting period expires (“exercisable”). An option is considered “in-the-money” when the underlying company’s share price surpasses the option’s exercise price.

A warrant is a security typically issued in conjunction with a debt instrument that entitles the purchaser of that instrument to buy shares of the issuer’s common stock at a set price during a given time period. In this context, warrants serve to entice investor interest (usually as a detachable equity “sweetener”) in riskier classes of securities such as non-investment grade bonds and mezzanine debt, by providing an increase to the security’s overall return.

For trading comps, the banker typically uses the company’s share price as of the prior day’s close as the basis for calculating equity value and trading multiples.

Investment banks and finance professionals may differ as to whether they use “outstanding” or “exercisable” in-the-money options and warrants in the calculation of fully diluted shares outstanding when performing trading comps. For conservatism (i.e., assuming the most dilutive scenario), many firms employ all outstanding in-the-money options and warrants as opposed to just exercisable as they represent future claims against the company.

While the overall volume of issuance for convertible and equity-linked securities is less than that for straight debt instruments, they are relatively common in certain sectors.

For GAAP reporting purposes (e.g., for EPS and fully diluted shares outstanding), the if-converted method requires issuers to measure the dilutive impact of the security through a two-test process. First, the issuer needs to test the security as if it were debt on its balance sheet, with the stated interest expense reflected in net income and the underlying shares omitted from the share count. Second, the issuer needs to test the security as if it were converted into equity, which involves excluding the interest expense from the convert in net income and including the full underlying shares in the share count. Upon completion of the two tests, the issuer is required to use the more dilutive of the two methodologies.

Effective for fiscal years beginning after December 15, 2008, the Financial Accounting Standards Board (FASB) put into effect new guidelines for NSS accounting. These changes effectively bifurcate an NSS convert into its debt and equity components, resulting in higher reported interest expense due to the higher imputed cost of debt. However, the new guidelines do not change the calculation of shares outstanding in accordance with the TSM. Therefore, one should consult with a capital markets specialist for accounting guidance on in-the-money converts with NSS features.

The NSS feature may also be structured so that the issuer can elect to settle the excess conversion value in cash.

As the company’s share price increases, the amount of incremental shares issued also increases as the spread between conversion and par value widens.

Formerly known as “minority interest,” noncontrolling interest is a significant, but non-majority, interest (less than 50%) in a company’s voting stock by another company or an investor. Effective for fiscal years beginning after December 15, 2008, FAS 160 changed the accounting and reporting for minority interest, which is now called noncontrolling interest and can be found in the shareholders’ equity section of a company’s balance sheet. On the income statement, the noncontrolling interest holder’s share of income is subtracted from net income.

These illustrative scenarios ignore financing fees associated with the debt and equity issuance as well as potential breakage costs associated with the repayment of debt. See Chapter 4: Leveraged Buyouts for additional information.

Circumstances whereby a company is unable or struggles to meet its credit obligations, typically resulting in business disruption, insolvency, or bankruptcy. As the perceived risk of financial distress increases, equity value generally decreases accordingly.

COGS, as reported on the income statement, may include or exclude D&A depending on the filing company. If D&A is excluded, it is reported as a separate line item on the income statement.

In the event a company reports D&A as a separate line item on the income statement (i.e., broken out separately from COGS and SG&A), EBITDA can be calculated as sales less COGS less SG&A.

EBIT may differ from operating income/profit due to the inclusion of income generated outside the scope of a company’s ordinary course business operations (“other income”).

Variable costs change depending on the volume of goods produced and include items such as materials, direct labor, transportation, and utilities. Fixed costs remain more or less constant regardless of volume and include items such as lease expense, advertising and marketing, insurance, corporate overhead, and administrative salaries. These costs are usually captured in the SG&A (or equivalent) line item on the income statement.

Represents a three-to-five-year estimate of annual EPS growth, as reported by equity research analysts.

Not all companies choose to pay dividends to their shareholders.

Ratings agencies provide opinions, but do not conduct audits.

Ratings are assessed on the issuer (corporate credit ratings) as well as on the individual debt instruments (facility ratings).

If available, quarterly estimates should be used as the basis for calendarizing financial projections.

In the event the SEC filing footnotes do not provide detail on the after-tax amounts of such adjustments, the banker typically uses the marginal tax rate. The marginal tax rate for U.S. corporations is the rate at which a company is required to pay federal, state, and local taxes. The highest federal corporate income tax rate for U.S. corporations is 35%, with state and local taxes typically adding another 2% to 5% or more (depending on the state). Most public companies disclose their federal, state and local tax rates in their 10-Ks in the notes to their financial statements.

A registration statement/prospectus is a filing prepared by an issuer upon the registration /issuance of public securities, including debt and equity. The primary SEC forms for registration statements are S-1, S-3, and S-4; prospectuses are filed pursuant to Rule 424. When a company seeks to register securities with the SEC, it must file a registration statement. Within the registration statement is a preliminary prospectus. Once the registration statement is deemed effective, the company files the final prospectus as a 424 (includes final pricing and other key terms).

As previously discussed, however, the banker needs to confirm beforehand that the estimates have been updated for the announced deal prior to usage. Furthermore, certain analysts may only update NFY estimates on an “as contributed” basis for the incremental earnings from the transaction for the remainder of the fiscal year (as opposed to adding a pro forma full year of earnings).

Generally, the earnings for the next two calendar years.

“Net debt” is often defined to include all obligations senior to common equity.

For illustrative purposes, we assume that the number of fully diluted shares outstanding remains constant for each of the equity values presented. As discussed in Chapter 3: Discounted Cash Flow Analysis, however, assuming the existence of stock options, the number of fully diluted shares outstanding as determined by the TSM is dependent on share price, which in turn is dependent on equity value and shares outstanding (see Exhibit 3.31). Therefore, the target’s fully diluted shares outstanding and implied share price vary in accordance with its amount of stock options and their weighted average exercise price.

See Chapter 6: M&A Sale Process for an overview of the key documents and sources of information in an organized sale process.

Thomson Reuters SDC Platinum™ is a financial transactions database that provides detailed information on new issuances, M&A, syndicated loans, private equity, and more. Additional dedicated M&A transaction applications include Capital IQ and FactSet Mergerstat, both of which are subscription services.

An M&A transaction for public targets where shareholders approve the deal at a formal shareholder meeting pursuant to relevant state law. See Chapter 6: M&A Sale Process for additional information.

The requirement for a shareholder vote in this situation arises from the listing rules of the New York Stock Exchange and the Nasdaq Stock Market. If the amount of shares being issued is less than 20% of pre-deal levels, or if the merger consideration consists entirely of cash or debt, the acquirer’s shareholders are typically not entitled to vote on the transaction.

When both the acquirer and target are required to prepare proxy and/or registration statements, they typically combine the statements in a joint disclosure document.

A tender offer is an offer to purchase shares for cash. An acquirer can also effect an exchange offer, pursuant to which the target’s shares are exchanged for shares of the acquirer.

Debt securities are typically sold to qualified institutional buyers (QIBs) through a private placement under Rule 144A of the Securities Act of 1933 initially, and then registered with the SEC within one year after issuance so that they can be traded on an open exchange. This is done to expedite the sale of the debt securities as SEC registration, which involves review of the registration statement by the SEC, can take several weeks or months. Once the SEC review of the documentation is complete, the issuer conducts an exchange offer pursuant to which investors exchange the unregistered bonds for registered bonds.

A joint proxy/registration statement typically incorporates the acquirer’s and target’s applicable 10-K and 10-Q by reference as the source for financial information.

A company “goes private” when it engages in certain transactions that have the effect of delisting its shares from a public stock exchange. In addition, depending on the circumstances, a publicly held company may no longer be required to file reports with the SEC when it reduces the number of its shareholders to fewer than 300.

Generally, an acquisition is required to be reported in an 8-K if the assets, income, or value of the target comprise 10% or greater of the acquirer’s. Furthermore, for larger transactions where assets, income, or value of the target comprise 20% or greater of the acquirer’s, the acquirer must file an 8-K containing historical financial information on the target and pro forma financial information within 75 days of the completion of the acquisition.

The proxy statement may contain more recent share count information than the 10-K or 10-Q.

Assumes that all unvested options and warrants vest upon a change of control (which typically reflects actual circumstances) and that no better detail exists for strike prices than that mentioned in the 10-K or 10-Q.

In a fixed exchange ratio deal, a collar can be used to guarantee a certain range of prices to the target’s shareholders. For example, a target may agree to a $20.00 offer price per share based on an exchange ratio of 1:2, with a collar guaranteeing that the shareholders will receive no less than $18.00 and no more than $22.00, regardless of how the acquirer’s shares trade between signing and closing.

Factors considered by the market when evaluating a proposed transaction include strategic merit, economics of the deal, synergies, and likelihood of closing.

Legal contract between a buyer and seller that governs the sharing of confidential company information. See Chapter 6: M&A Sale Process for additional information. In the event the banker performing transaction comps is privy to non-public information regarding one of the selected comparable acquisitions, the banker must refrain from using that information in order to maintain client confidentiality.

Sixty, 90, 180, or an average of a set number of calendar days prior, as well as the 52-week high and low, may also be reviewed.

Pearl is also a comparable company to ValueCo (see Chapter 1, Exhibits 1.53, 1.54, and 1.55).

See Chapter 4: Leveraged Buyouts and Chapter 5: LBO Analysis for a discussion of levered free cash flow or cash available for debt repayment.

For example, assuming a 10% discount rate and a one year time horizon, the discount factor is 0.91 (1/(1+10%)^1), which implies that one dollar received one year in the future would be worth $0.91 today.

Including those companies that have outstanding registered debt securities, but do not have publicly traded stock.

For companies with COGS that can be driven on a unit volume/cost basis, COGS is typically projected on the basis of expected volumes sold and cost per unit. Assumptions governing expected volumes and cost per unit can be derived from historical levels, production capacity, and/or sector trends.

If the model is built on the basis of COGS and SG&A detail, the banker must ensure that the EBITDA and EBIT consensus estimates dovetail with those assumptions. This exercise may require some triangulation among the different inputs to ensure consistency.

The extent to which sales growth results in growth at the operating income level; it is a function of a company’s mix of fixed and variable costs.

It is important to understand that a company’s effective tax rate, or the rate that it actually pays in taxes, often differs from the marginal tax rate due to the use of tax credits, non-deductible expenses (such as government fines), deferred tax asset valuation allowances, and other company-specific tax policies.

D&A for GAAP purposes typically differs from that for federal income taxes. For example, federal government tax rules generally permit a company to depreciate assets on a more accelerated basis than GAAP. These differences create deferred liabilities. Due to the complexity of calculating tax D&A, the banker typically uses GAAP D&A as a proxy for tax D&A.

A schedule for determining a company’s PP&E for each year in the projection period on the basis of annual capex (additions) and depreciation (subtractions). PP&E for a particular year in the projection period is the sum of the prior year’s PP&E plus the projection year’s capex less the projection year’s depreciation.

When using consensus estimates for EBITDA and EBIT, the difference between the two may imply a level of D&A that is not defensible. This situation is particularly common when there are a different number of research analysts reporting values for EBITDA than for EBIT.

Indefinite life intangible assets, most notably goodwill (value paid in excess over the book value of an asset), are not amortized. Rather, goodwill is held on the balance sheet and tested annually for impairment.

For the purposes of the DCF, working capital ratios are generally measured on an annual basis.

The financing mix that minimizes WACC, thereby maximizing a company’s theoretical value.

Technically, a bond’s current yield is calculated as the annual coupon on the par value of the bond divided by the current price of the bond. However, callable bond yields are typically quoted at the yield-to-worst call (YTW). A callable bond has a call schedule (defined in the bond’s indenture) that lists several call dates and their corresponding call prices. The YTW is the lowest calculated yield when comparing all of the possible yield-to-calls from a bond’s call schedule given the initial offer price or current trading price of the bond.

See Chapter 4: Leveraged Buyouts for additional information on term loans and other debt instruments.

T-bills are non-interest-bearing securities issued with maturities of 3 months, 6 months, and 12 months at a discount to face value. T-notes and bonds, by contrast, have a stated coupon and pay semiannual interest. T-notes are issued with maturities of between one and ten years, while T-bonds are issued with maturities of more than ten years.

Yields on nominal Treasury securities at “constant maturity” are interpolated by the U.S. Treasury from the daily yield curve for non-inflation-indexed Treasury securities. This curve, which relates the yield on a security to its time-to-maturity, is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market.

Bloomberg function: “ICUR {# years} <GO>.” For example, the interpolated yield for a 10-year Treasury note can be obtained from Bloomberg by typing “ICUR10,” then pressing <GO>.

Located under “Daily Treasury Yield Curve Rates.”

The 30-year Treasury bond was discontinued on February 18, 2002, and reintroduced on February 9, 2006.

Morningstar acquired Ibbotson Associates in March 2006. Ibbotson Associates is a leading authority on asset allocation, providing products and services to help investment professionals obtain, manage, and retain assets. Morningstar’s annual Ibbotson^® SBBI^® (Stocks, Bonds, Bills, and Inflation) Valuation Yearbook is a widely used reference for cost of capital input estimations for U.S.-based businesses.

Bloomberg function: “ICUR20” <GO>.

While there are currently no 20-year Treasury bonds issued by the U.S. Treasury, as long as there are bonds being traded with at least 20 years to maturity, there will be a proxy for the yield on 20-year Treasury bonds.

The S&P 500^® is typically used as the proxy for the return on the market.

Expected risk premium for equities is based on the difference of historical arithmetic mean returns for the 1926 to 2007 period. Arithmetic annual returns are independent of one another. Geometric annual returns are dependent on the prior year’s returns.

Bloomberg function: Ticker symbol <Equity> BETA <GO>.

MSCI Barra is a leading provider of investment decision support tools and supplies predicted betas for most public companies among other products and services. MSCI Barra uses a proprietary multi-factor risk model, known as the Multiple-Horizon U.S. Equity Model™, which relies on market information, fundamental data, regressions, historical daily returns, and other risk analyses to predict beta. MSCI Barra betas can be obtained from Alacra, among other financial information services.

Market value of equity.

Average unlevered beta may be calculated on a market-cap weighted basis.

May not be appropriate for highly seasonal businesses.

This is a common pitfall in the event that management projections (Management Case) are used without independently analyzing and testing the underlying assumptions.

We also displayed ValueCo’s full year 2008E financial data, for which we have reasonable comfort given its proximity at the end of Q3 2008. For the purposes of the DCF valuation, we used 2009E as the first full year of projections. An alternative approach is to include the “stub” period FCF (i.e., for Q4 2008E) in the projection period and adjust the discounting for a quarter year.

Alternatively, ValueCo’s cost of debt could be extrapolated from that of its peers. We took comfort with using the current yield on ValueCo’s existing term loan because its current capital structure is in line with its peers.

A basis point is a unit of measure equal to 1/100th of 1% (100 bps = 1%).

The London Interbank Offered Rate (LIBOR) is the rate of interest at which banks can borrow funds from other banks, in marketable size, in the London interbank market.

An alternate approach is to use historical betas (e.g., from Bloomberg), or both historical and predicted betas, and then show a range of outputs.

For simplicity, we assumed that the market value of debt was equal to the book value.

Ibbotson estimates a size premium of 1.65% for companies in the Low-Cap Decile for market capitalization.

Depending on the long-term structural effects of the subprime mortgage crisis and ensuing credit crunch, including the ability to raise debt at historical levels, these long-established benchmarks may be revisited.

The “free cash flow” term (“levered free cash flow” or “cash available for debt repayment”) used in LBO analysis differs from the “unlevered free cash flow” term used in DCF analysis as it includes the effects of leverage.

The term “investment bank” is used broadly to refer to financial intermediaries that perform corporate finance and M&A advisory services, as well as capital markets underwriting activities.

These letters are typically highly negotiated among the sponsor, the banks providing the financing, and their respective legal counsels before they are executed.

To compensate the GP for management of the fund, LPs typically pay 1% to 2% per annum on committed funds as a management fee. In addition, once the LPs have received the return of every dollar of committed capital plus the required investment return threshold, the sponsor typically receives a 20% “carry” on every dollar of investment profit.

LPs generally hold the capital they invest in a given fund until it is called by the GP in connection with a specific investment.

The investment bank running an auction process (or sometimes a “partner” bank) may offer a pre-packaged financing structure, typically for prospective financial buyers, in support of the target being sold. This is commonly referred to as stapled financing (“staple”). See Chapter 6: M&A Sale Process for additional information.

Alternatively, the banks may be asked to commit to a financing structure already developed by the sponsor.

The financing commitment includes: a commitment letter for the bank debt and a bridge facility (to be provided by the lender in lieu of a bond financing if the capital markets are not available at the time the acquisition is consummated); an engagement letter, in which the sponsor engages the investment banks to underwrite the bonds on behalf of the issuer; and a fee letter, which sets forth the various fees to be paid to the investment banks in connection with the financing. Traditionally, in an LBO, the sponsor has been required to provide certainty of financing and, therefore, had to pay for a bridge financing commitment even if it was unlikely that the bridge would be funded.

The fees associated with the commitment compensate the banks for their underwriting role and the risk associated with the pledge to fund the transaction in the event that a syndication to outside investors is not achievable.

The credit crunch has resulted in certain sellers loosening this requirement and accepting bids with financing conditions.

The primary investment banks responsible for marketing the bank debt, including the preparation of marketing materials and running the syndication, are referred to as “Lead Arrangers” or “Bookrunners.”

The lead investment banks responsible for marketing the high yield bonds or mezzanine debt are referred to as “Bookrunners.”

CDOs are asset-backed securities (“securitized”) backed by interests in pools of assets, usually some type of debt obligation. When the interests in the pool are loans, the vehicle is called a collateralized loan obligation (CLO). When the interests in the pool are bonds, the vehicle is called a collateralized bond obligation (CBO).

For particularly large or complex transactions, the target’s management may present to lenders on a one-on-one basis.

The bank book is a comprehensive document that contains a detailed description of the transaction, investment highlights, company, and sector, as well as preliminary term sheets and historical and projected financials. In the event that publicly registered bonds are contemplated as part of the offering, two versions of the CIM are usually created—a public version and a private version (or private supplement). The public version, which excludes financial projections and forward-looking statements, is distributed to lenders who intend to purchase bonds or other securities that will eventually be registered with the SEC. The private version, on the other hand, includes financial projections as it is used by investors that intend to invest solely in the company’s unregistered debt (i.e., bank debt). Both the bank meeting presentation and bank book are typically available to lenders through an online medium.

For example, roadshow schedules often include stops in Philadelphia, Baltimore, Minneapolis, Milwaukee, Chicago, and Houston, as well as various cities throughout New Jersey and Connecticut, in accordance with where the underwriters believe there will be investor interest.

European roadshows include primary stops in London, Paris, and Frankfurt, as well as secondary stops typically in Milan, Edinburgh, Zurich, and Amsterdam.

A discussion of the most significant factors that make the offering speculative or risky.

Laws that set forth requirements for securities listed on public exchanges, including registration and periodic disclosures of financial status, among others.

The DON contains an overview of the material provisions of the bond indenture including key definitions, terms, and covenants.

These option incentives may comprise up to 15% of the equity value of the company (and are realized by management upon a sale or IPO).

The Sarbanes-Oxley Act of 2002 enacted substantial changes to the securities laws that govern public companies and their officers and directors in regards to corporate governance and financial reporting. Most notably, Section 404 of SOX requires public registrants to establish and maintain “Internal Controls and Procedures,” which can consume significant internal resources, time, commitment, and expense.

A roll-up strategy involves consolidating multiple companies in a given market or sector to create an entity with increased size, scale, and efficiency.

Selling the target for a higher multiple of EBITDA upon exit (i.e., purchasing the target for 7.0x EBITDA and selling it for 8.0x EBITDA).

Based on the sponsor’s model. See Chapter 5: LBO Analysis for additional information.

Debt incurrence and restricted payments covenants in the target’s existing operating company level (“OpCo”) debt often substantially limit both incremental debt and the ability to pay a dividend to shareholders (see Exhibits 4.22 and 4.23). Therefore, dividend recaps frequently involve issuing a new security at the holding company level (“HoldCo”), which is not subject to the existing OpCo covenants.

Lenders to the facility focus on the ability of the borrower to cover debt service by generating cash flow.

Lenders to the facility focus on the liquidation value of the assets comprising the facility’s borrowing base, typically accounts receivable and inventory (see Exhibit 4.15).

As a private market instrument, bank debt is not subject to the Securities Act of 1933 and the Securities Exchange Act of 1934, which require periodic public reporting of financial and other information.

Base Rate is most often defined as a rate equal to the higher of the prime rate or the Federal Funds rate plus 1/2 of 1%.

The legal contract between the borrower and its lenders that governs bank debt. It contains key definitions, terms, representations and warranties, covenants, events of default, and other miscellaneous provisions.

An LC is a document issued to a specified beneficiary that guarantees payment by an “issuing” lender under the credit agreement. LCs reduce revolver availability.

The fee is assessed on an ongoing basis and accrues daily, typically at an annualized rate up to 50 basis points (bps) depending on the credit of the borrower. For example, an undrawn $100 million revolver would typically have an annual commitment fee of 50 bps or $500,000 ($100 million × 0.50%). Assuming the average daily revolver usage (including the outstanding LC amounts) is $25 million, the annual commitment fee would be $375,000 (($100 million $25 million) × 0.50%). For any drawn portion of the revolver, the borrower pays interest on that dollar amount at LIBOR or the Base Rate plus a spread. To the extent the revolver’s availability is reduced by outstanding LCs, the borrower pays a fee on the dollar amount of undrawn outstanding LCs at the full spread, but does not pay LIBOR or the Base Rate. Banks may also be paid an up-front fee upon the initial closing of the revolver and term loan(s) to incentivize participation.

For example, in the tangible and intangible assets of the borrower, including capital stock of subsidiaries.

As well as its domestic subsidiaries (in most cases).

The traditional springing financial covenant is a fixed charge coverage ratio of 1.0x and is tested only if “excess availability” falls below a certain level (usually 10% to 15% of the ABL facility). Excess availability is equal to the lesser of the ABL facility or the borrowing base less, in each case, outstanding amounts under the facility.

Pari passu (or on an equal basis) with the revolver, which entitles term loan lenders to an equal right of repayment upon bankruptcy of the borrower.

A mandatory repayment schedule for a TLA issued at the end of 2008 with a six-year maturity might be structured as follows: 2009: 10%, 2010: 10%, 2011: 15%, 2012: 15%, 2013: 25%, 2014: 25%. Another example might be: 2009: 0%, 2010: 0%, 2011: 5%, 2012: 5%, 2013: 10%, 2014: 80%. The amortization schedule is typically set on a quarterly basis.

A large repayment of principal at maturity that is standard among institutional term loans. A typical mandatory amortization schedule for a TLB issued at the end of 2008 with a seven-year maturity would be as follows: 2009: 1%, 2010: 1%, 2011: 1%, 2012: 1%, 2013: 1%, 2014: 1%, 2015: 94%. Like TLAs, the amortization schedule for B term loans is typically set on a quarterly basis. The sizeable 2015 principal repayment is referred to as a bullet.

High yield bonds can also be structured with a second lien.

Exact terms and rights between first and second lien lenders are set forth in an intercreditor agreement.

The legal contract entered into by an issuer and corporate trustee (who acts on behalf of the bondholders) that defines the rights and obligations of the issuer and its creditors with respect to a bond issue. Similar to a credit agreement for bank debt, an indenture sets forth the covenants and other terms of a bond issue.

As part of Rule 144A, the SEC created another category of financially sophisticated investors known as qualified institutional buyers, or QIBs. Rule 144A provides a safe harbor exemption from federal registration requirements for the resale of restricted securities to QIBs. QIBs generally are institutions or other entities that, in aggregate, own and invest (on a discretionary basis) at least $100 million in securities.

PIK toggle notes are rare (or non-existent) during more normalized credit market conditions.

Investment banks are paid a commitment fee for arranging the bridge loan facility regardless of whether the bridge is funded. In the event the bridge is funded, the banks and lenders receive an additional funding fee. Furthermore, if the bridge remains outstanding after one year, the borrower also pays a conversion fee.

In Europe, mezzanine debt is used to finance large as well as middle market transactions. It is typically structured as a floating rate loan (with a combination of cash and PIK interest) that benefits from a second or third lien on the same collateral benefiting the bank debt (of the same capital structure). U.S. mezzanine debt, on the other hand, is typically structured with a fixed rate coupon and is contractually subordinated (see Exhibit 4.19), thereby not benefiting from any security.

However, if an LBO financing structure has both high yield bonds and mezzanine debt, the mezzanine debt will typically mature outside the high yield bonds, thereby reducing the risk to the more senior security.

As previously discussed, the commitment papers for the debt financing are typically predicated on a minimum equity contribution by the sponsor.

In practice, in the event a material default is not waived by a borrower/issuer’s creditors, the borrower/issuer typically seeks protection under Chapter 11 of the Bankruptcy Code to continue operating as a “going concern” while it attempts to restructure its financial obligations. During bankruptcy, while secured creditors are generally stayed from enforcing their remedies, they are entitled to certain protections and rights not provided to unsecured creditors (including the right to continue to receive interest payments). Thus, obtaining collateral can be beneficial to a creditor even if it does not exercise its remedies to foreclose and sell that collateral.

Creditors owed money for goods and services.

When the transaction involves junior debt not governed by an indenture (e.g., privately placed second lien or mezzanine debt), the subordination provisions will generally be included in an intercreditor agreement with the senior creditors.

A legal entity that owns all or a portion of the voting stock of another company/entity, in this case, OpCo.

Guarantees provide credit support by one party for a debt obligation of a third party. For example, a subsidiary with actual operations and assets “guarantees” the debt, meaning that it agrees to use its cash and assets to pay debt obligations on behalf of HoldCo.

Redemption of bonds prior to the 1st call date requires the company to pay investors a premium, either defined in the indenture (“make-whole provision”) or made in accordance with some market standard (typically a tender at the greater of par or Treasury Rate (T) + 50 bps). The tender premium calculation is based on the sum of the value of a bond’s principal outstanding at the 1st call date (e.g., 105% of face value for a 10% coupon bond) plus the value of all interest payments to be received prior to the 1st call date from the present time, discounted at the Treasury Rate for an equivalent maturity plus 50 bps.

High yield bonds also often feature an equity clawback provision, which allows the issuer to call a specified percentage of the outstanding bonds (typically 35%) with net proceeds from an equity offering at a price equal to par plus a premium equal to the coupon (e.g., 110% for a 10% coupon bond).

For illustrative purposes, the call protection period for a 2nd lien term loan may be structured as NC-1. At the end of one year, the loan would typically be prepayable at a price of $102.00, stepping down to $101.00 after two years, and then par after three years.

“Covenant-lite” loans, a feature in the leveraged loan market that experienced a surge during the credit boom of the mid-2000s, represents an exception to the aforementioned norms. Covenant-lite packages were typically similar to that of high yield bonds, featuring incurrence covenants as opposed to financial maintenance covenants. Covenant-lite term loans in LBO financing structures were more typical when structured alongside an ABL facility because commercial banks would not agree to covenant-lite cash flow revolvers unless the revolver benefited from a super-priority security interest in the collateral.

Toggles may also be created to activate the 100% cash flow sweep, cash balance sweep, average interest expense option, or other deal-specific toggles.

The length of the projection period provided in a CIM (or through another medium) may vary depending on the situation.

The timing for the sharing of the Sponsor Model depends on the specifics of the particular deal and the investment bank’s relationship with the sponsor.

If the banker is analyzing a public company as a potential LBO candidate outside of (or prior to) an organized sale process, the latest balance sheet data from the company’s most recent 10-K or 10-Q is typically used.

The “free cash flow” term used in an LBO analysis differs from that used in a DCF analysis as it includes the effects of leverage.

As ValueCo is private, we entered a “2” in the toggle cell for public/private target (see Exhibit 5.12).

In this case, a “1” would be entered in the toggle cell for public/private target (see Exhibit 5.13).

In the event the target has debt being refinanced with associated breakage costs (e.g., call or tender premiums), those expenses are included in the uses of funds.

In accordance with FAS 141(R), M&A transaction costs are expensed as incurred. Debt financing fees, however, continue to be treated as deferred costs and amortized over the life of the associated debt instruments.

The allocation of the entire purchase price premium to goodwill is a simplifying assumption for the purposes of this analysis. In an actual transaction, the excess purchase price over the existing book value of equity is allocated to assets, such as PP&E and intangibles, as well as other balance sheet items, to reflect their fair market value at the time of the acquisition. The remaining excess purchase price is then allocated to goodwill. From a cash flow perspective, in a stock sale (see Exhibit 6.10), there is no difference between allocating the entire purchase premium to goodwill as opposed to writing up other assets to fair market value. In an asset sale (see Exhibit 6.10), however, there are differences in cash flows depending on the allocation of goodwill to tangible and intangible assets as the write-up is tax deductible.

Although financing fees are paid in full to the underwriters at transaction close, they are amortized in accordance with the tenor of the security for accounting purposes. Deferred financing fees from prior financing transactions are typically expensed when the accompanying debt is retired and show up as a one-time charge to the target’s net income, thereby reducing retained earnings and shareholders’ equity.

Fees are dependent on the debt instrument, market conditions, and specific situation. The fees depicted are for illustrative purposes only and indicative of those used during the mid-2000s.

The bank that monitors the credit facilities including the tracking of lenders, handling of interest and principal payments, and associated back-office administrative functions.

The fee for the first year of the facility is generally paid to the lead arranger at the close of the financing.

In lieu of a debt schedule, some LBO model templates use formulas in the appropriate cells in the financing activities section of the cash flow statement and the interest expense line item(s) of the income statement to perform the same functions.

3-month LIBOR is generally used.

Bloomberg function: “FWCV,” select “US” (if pricing is based on U.S. LIBOR).

Following the onset of the subprime mortgage crisis and the ensuing credit crunch, and the resulting rate cuts by the Federal Reserve, investors have insisted on “LIBOR floors” in many new bank deals. A LIBOR floor guarantees a minimum coupon for investors regardless of how low LIBOR falls. For example, a term loan priced at L+350 bps with a LIBOR floor of 325 bps will have a cost of capital of 6.75% even if the prevailing LIBOR is lower than 325 bps.

Mandatory repayments are determined in accordance with each debt instrument’s amortization schedule.

To the extent the revolver is used, the commitment expense will decline and ValueCo will be charged interest on the amount of the revolver draw at L+325 bps.

Credit agreements typically also have a provision requiring the borrower to prepay term loans in an amount equal to a specified percentage (and definition) of excess cash flow and in the event of specified asset sales and issuances of certain debt or equity.

Some credit agreements give credit to the borrower for voluntary repayments on a go-forward basis and/or may require pro rata repayment of certain tranches.

At this point, a circular reference centering on interest expense has been created in the model. Interest expense is used to calculate net income and determine cash available for debt repayment and ending debt balances, which, in turn, are used to calculate interest expense. The spreadsheet must be set up to perform the circular calculation (in Microsoft Excel) by selecting Tools, Options, clicking on the “Calculation” tab, checking the box next to “Iteration,” and setting the “Maximum iterations” field to 1000 (see Exhibit 3.30).

Assumes a 3% interest rate earned on cash (using an average balance method), which is indicative of a short-term money market instrument.

While a cash balance of zero may be unrealistic from an operating perspective, it is a relatively common modeling convention.

Refers to the practice of replacing an initial bid with a lower one at a later date.

In some circumstances, the auction is actually made public by the seller to encourage all interested buyers to come forward and state their interest in the target.

In Delaware (which generally sets the standards upon which many states base their corporate law), when the sale of control or the break-up of a company has become inevitable, the directors have the duty to obtain the highest price reasonably available. There is no statutory or judicial “blueprint” for an appropriate sale or auction process. Directors enjoy some latitude in this regard, so long as the process is designed to satisfy the directors’ duties by ensuring that they have reasonably informed themselves about the company’s value.

Ultimately, buyers who require financing to complete a deal will typically work with multiple banks to ensure they are receiving the most favorable financing package (debt quantum, pricing, and terms) available in the market.

Refers to the total size of the fund as well as remaining equity available for investment.

As set forth in the agreement between the fund’s GP and LPs, refers to how long the fund will be permitted to seek investments prior to entering a harvest and distribution phase.

Typically, counsel closely scrutinizes any discussion of a business combination (i.e., in a strategic transaction) as marketing materials will be subjected to scrutiny by antitrust authorities in connection with their regulatory review.

The initial buyer contact or teaser can put a public company “in play” and may constitute the selective disclosure of material information (i.e., that the company is for sale).

Typically one-to-two years for financial sponsors and potentially longer for strategic buyers.

May also be crafted as a separate legal document outside of the CA.

In some cases, the CA must be signed prior to receipt of any information, including the teaser, depending on seller sensitivity.

Calls are usually commenced one-to-two weeks prior to the CIM being printed to allow sufficient time for the negotiation of CAs. Ideally, the sell-side advisor prefers to distribute the CIMs simultaneously to provide all prospective buyers an equal amount of time to consider the investment prior to the bid due date.

Each CIM is given a unique control number that is used to track each party that receives a copy.

For acquisitions of private companies, buyers are typically asked to bid assuming the target is both cash and debt free.

Prior to the establishment of web-based data retrieval systems, data rooms were physical locations (i.e., offices or rooms, usually housed at the target’s law firm) where file cabinets or boxes containing company documentation were set up. Today, however, most data rooms are online sites where buyers can view all the necessary documentation remotely. Among other benefits, the online process facilitates the participation of a greater number of prospective buyers as data room documents can be reviewed simultaneously by different parties. They also enable the seller to customize the viewing, downloading, and printing of various data and documentation for specific buyers.

Sensitive information (e.g., customer, supplier, and employment contracts) is generally withheld from competitor bidders until later in the process.

Due diligence in these instances may be complicated by the need to limit the prospective buyers’ access to highly sensitive information that the seller is unwilling to provide.

Like the initial bid procedures letter, for private targets, the buyer is typically asked to bid assuming the target is both cash and debt free. If the target is a public company, the bid will be expressed on a per share basis.

Indemnities are generally only included for the sale of private companies or divisions/assets of public companies.

Frequently, the seller’s disclosure schedules, which qualify the representations and warranties made by the seller in the definitive agreement and provide other vital information to making an informed bid, are circulated along with the draft definitive agreement.

Historically, the investment bank serving as sell-side advisor to the target has typically rendered the fairness opinion. This role was supported by the fact that the sell-side advisor was best positioned to opine on the offer on the basis of its extensive due diligence and intimate knowledge of the target, the process conducted, and detailed financial analyses already performed. In recent years, however, the ability of the sell-side advisor to objectively evaluate the target has come under increased scrutiny. This line of thinking presumes that the sell-side advisor has an inherent bias toward consummating a transaction when a significant portion of the advisor’s fee is based on the closing of the deal and/or if a stapled financing is provided by the advisor’s firm to the winning bidder. As a result, some sellers hire a separate investment bank/boutique to render the fairness opinion from an “independent” perspective that is not contingent on the closing of the transaction.

Depending on the industry (e.g., banking, insurance, and telecommunications), other regulatory approvals may be necessary.

For public companies, the SEC requires that a proxy statement includes specific information as set forth in Schedule 14A. These information requirements, as relevant in M&A transactions, generally include a summary term sheet, background of the transaction, recommendation of the board(s), fairness opinion(s), summary financial and pro forma data, and the definitive agreement, among many other items either required or deemed pertinent for shareholders to make an informed decision on the transaction.

Large transactions in highly regulated industries, such as telecommunications, can often take more than a year to close because of the lengthy regulatory review.

A tender offer is an offer to purchase shares for cash. An acquirer can also effect an exchange offer, pursuant to which the target’s shares are exchanged for shares of the acquirer.

Although the tender offer documents are also filed with the SEC and subject to its scrutiny, as a practical matter, the SEC’s comments on tender offer documents rarely interfere with, or extend, the timing of the tender offer.