1. Special Appendix 2
Leveraged Buyouts

2. Leveraged buyouts
“Shell corporation” is formed to acquire existing company
Investor group often includes existing employees
Heavy debt financing used to provide funds for stock purchase
Purchase accounting methods are applied with modifications
SA#2

3. + + Valuing an LBO Fair value block Equity-Adjusted block
Book Value block
SA#2

4. Fair value block Shares of new shareholders and
Shares held in prior company if residual interest does not exceed 5% in new company
subject to constraints
Residual interest: all outstanding common stock and those preferred shares that do not have liquidation or redemption features.
SA#2

5. Fair value block, continued
Constraints on inclusion of prior company shares:
Individual’s residual ownership percentage has increased
does not exceed 5% of new company
SA#2

6. Fair value block, continued
Constraints on inclusion (continued):
Individual’s residual ownership percentage has decreased
individual's voting interest in common stock < 20% and
individual supplied < 20% of new company’s total capital (debt + equity)
individual’s new residual interest < 5% and
residual interest of all owners whose interest decreased < 20%
SA#2

7. Fair value block, continued
Limitation on number of shares to include in fair value block:
If monetary consideration < 80%
shares comprising market value block is limited
total common shares outstanding times the monetary consideration percentage
If monetary consideration  80%
no limitation
Monetary consideration:
cash + debt + debt-type securities
SA#2

8. Equity-adjusted cost block
Shares that do not qualify for the fair value block
Recorded at their simple-equity-adjusted cost basis
Shareholders are referred to as “continuing”
SA#2

9. Book value block
Shares that qualified for the market block but were eliminated by the monetary consideration constraint
for example, if 85% of the shares met the market block test, but monetary consideration was 70%, this would be the 15% disqualified block.
SA#2

10. Recording a leveraged buyout
The transaction is recorded as a modified direct asset acquisition using purchase rules
Accounts are recorded at the sum of 3 possible values
SA#2

11. Recording a leveraged buyout, continued
Assume the blocks are 70% market, 20% equity, 10% book
Market Portion - a 70% D&D schedule will assign the market value available to each account.
Equity Portion - a 20% D&D schedule will assign the equity adjusted cost available to each account.
Book Value Portion - 10% of each account remains at book value
SA#2