LBO Model: Sources & Uses (17:20)
Why Does the Sources & Uses Schedule Matter? Key part of an LBO (leveraged buyout) model — what you’re paying for (the Uses) must equal how much you’re putting in (the Sources).
Similar to the conservation of energy or momentum in physics, *money* must be conserved in a transaction like this — cannot be created or destroyed.
But the real point is that this schedule determines the amount of CASH (equity) the private equity firm must contribute to a leveraged buyout transaction.
Higher cash contribution = lower IRR, all else being equal, and lower cash contribution =
higher IRR, all else being equal.
This schedule also tells you the OWNERSHIP in a company post-LBO — can add up the cash contribution from all parties (e.g. PE firm, Founder, management team) and divide each contribution by the total to get the ownership percentages.
And it explains why activist shareholders like Carl Icahn often hate these types of deals — can hugely increase the Founder’s stake or management’s stake, and remove all upside from the existing shareholders!
What Goes Into a Sources & Uses Schedule, and How Do You Build One?
Uses Side — Most common items are the Equity Purchase Price of the company (how much it costs to acquire all their shares), plus transaction fees, and any debt that is repaid in the course of the deal.
Sources Side — The most common items are all the different types of debt you use to buy the company, and then the cash (equity) the PE firm contributes to close the gap.
How to Calculate It:
1. Always START with the Uses side and calculate everything there, adding up the total at the bottom.
2. Then go to the Sources side and link in all the debt (and other funding sources) you’re using.
3. Then, calculate Investor Equity by setting it equal to Total Uses — “Sources So Far” — all the sources of funding ABOVE the Investor Equity line item.
4. Finally, add up Total Sources at the bottom and ensure that it equals Total Uses.
More Complex Items for the Sources & Uses Schedule:
Debt Assumed — This appears under BOTH the Sources AND the Uses sides and has no impact on the cash required to do the deal. It simply stays on the Balance Sheet, so it’s both a Source and a Use of funds and doesn’t impact us at all.
Excess Cash Used — The company uses its own cash to purchase some of its shares required to complete the deal. This REDUCES the number of shares the PE firm must buy, and therefore reduces the amount the PE firm must pay, so it’s a Source of funds.
Founder or Management Rollover — If the Founder or management team owns a % of the company now and wants to keep it, this also reduces the amount the PE firm pays — and therefore it’s another Source of funding and only appears under Sources.
Additional Cash Contributions — The Founder or management team or other parties can also “up” their stake in the company by putting in additional cash into the deal. This reduces how much the PE firm must contribute, and increases the ownership of these other parties.
Rules of Thumb for All of These:
If an item DECREASES the cash a PE firm must contribute, it goes on the Sources side.
If an item INCREASES the cash a PE firm must contribute, it goes on the Uses side.
If an item makes NO IMPACT on the cash a PE firm must contribute, it goes on both sides of the schedule and is both a Source and a Use.
So Why Did the Dell LBO Piss Off Shareholders So Much?
Because Michael Dell went from owning ~15% of the company to ~78% and only put in a bit of extra cash to do so. And the company used its own cash to fund much of the deal.
They said to shareholders, “Hey, we’re going to buy your shares at a low-ball price and use our excess cash to buy many of them — we could have issued that cash to you as a big dividend and let you keep their shares, but we’re going to instead buy them from you at a fairly low price and remove any potential upside you have in this deal.”
Find a deal you’re interested in and try to create your own Sources & Uses schedule for it, based on press releases and company filings.
And be prepared for these questions in interviews, case studies, modeling tests, and more — this schedule is critical to all types of transaction modeling.