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Chapter 1 of 5 · 10 min

Sources and uses

Every buyout starts with a table that must balance: what the money is for, and where it comes from.

By the end of this chapter you can
  • Build total uses from the purchase price, debt refinanced and fees
  • Size the new debt and find the equity check as the plug
  • Work back from the equity check to the leverage
  • Explain why a higher price lands almost entirely on the sponsor
1

The intuition

Buying a house, you list what you need money for: the price, the lawyer and the taxes. Those are your uses. Then you list where the money comes from: the mortgage and your deposit. Those are your sources, and the two lists must add up to the same number.

The bank decides the mortgage from your income, not from the price you agreed. So if you pay more for the house, the mortgage stays the same and your deposit grows. The deposit is the plug.

The key idea

Uses = the price of the business + the fees. Lenders size the debt in turns of EBITDA. The sponsor's equity is whatever is left, so every extra dollar of price or fees is an extra dollar of equity.

2

Why it works

  • Enterprise value = EBITDA × the entry multiple. It is what the whole business costs.
  • The equity purchase price is enterprise value less the target's existing net debt: what the old shareholders receive.
  • Uses = equity purchase price + existing debt refinanced + fees. Buying the equity and repaying the debt together cost the enterprise value, so uses = enterprise value + fees.
  • Existing debt is refinanced because it usually falls due on a change of control, and the new lenders want to be the only ones with a claim on the assets.
  • New debt = turns of leverage × EBITDA. Lenders set it from the cash flow the business can service, not from the price.
  • Equity = uses − new debt. Management may roll part of it; the sponsor writes the rest.
EBITDA $100M at 10x; $200M of existing net debt; fees 2%; 5.0x of new debt; management rolls 10%
Enterprise value: 100 × 101,000
Equity purchase price: 1,000 − 200800
Uses: 800 + 200 of debt repaid + 20 of fees1,020
New debt: 5.0 × 100500
Total equity: 1,020 − 500520 (51.0% of sources)
Management rollover: 520 × 10%52
Sponsor check: 520 − 52468
3

The formulas

Enterprise value = EBITDA × entry multiple

What the business costs.

Equity purchase price = enterprise value − existing net debt

What the sellers receive for their shares.

Uses = equity purchase price + existing debt refinanced + fees = enterprise value + fees

Everything that must be paid at closing.

New debt = leverage turns × EBITDA

Lenders size off cash flow, not price.

Total equity = uses − new debt; sponsor check = total equity × (1 − rollover)

The plug, less what management reinvests.

Leverage implied = (uses − total equity) ÷ EBITDA

Run the table backwards.

4

Worked example

A full sources and uses table. Total the uses first; the equity falls out at the end.

Drawing the numbers…
5

See it move

Same deal. Change the price, the leverage, the fees, how much existing debt is repaid and how much management rolls.

Drawing the numbers…
Try this
  • Raise the entry multiple. Uses grow but the debt does not, because lenders size it off EBITDA, so every extra dollar lands on the equity.
  • Add a turn of leverage. Debt rises by one times EBITDA and the equity falls by exactly the same amount.
  • Change how much existing debt is repaid. Total uses do not move: buying the equity and repaying the debt always add up to enterprise value.
  • Raise the fees. Uses and the equity rise by the same amount. Add management rollover and the total equity stays put while the sponsor's share of it shrinks.
6

Run it backwards

Same deal, reversed: you know the price, the fees and the equity check. How much debt did the lenders provide?

Drawing the numbers…

Sources equal uses, so debt = uses − equity. Uses are enterprise value plus fees. Divide the debt by EBITDA to express it in turns.

Turns of EBITDA is how lenders and sponsors talk about leverage, so a press release that gives only the price and the equity still tells you how aggressive the financing was.

7

Traps

Sizing the debt as a share of the purchase price.
Lenders size it in turns of EBITDA. Pay more and the debt does not grow; the equity does.
Leaving the fees out of uses.
They are paid in cash at closing, so they need funding like the price does, and they raise the equity check one for one.
Adding the existing debt on top of enterprise value.
Enterprise value already includes it. The equity price plus the debt repaid equals enterprise value, so uses = enterprise value + fees.
Counting management rollover as sponsor money.
It is equity, but it comes from management reinvesting their proceeds. The sponsor's check is the rest.
Treating extra debt as free.
A smaller check raises returns, but more interest eats cash flow and tighter covenants leave less room if the plan slips.
8

Say it in the interview

The interviewer asks

“Walk me through a sources and uses table for an LBO.”

Say yours out loud first, then compare.
9

Check yourself

4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.

Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.

0 of 4
Drawing your questions…
Remember
  • Uses = enterprise value + fees.
  • Debt = turns × EBITDA, set by lenders.
  • Equity = uses − debt: the plug.
  • A higher price or higher fees land on the equity.