Question

Banks are financing acquisition projects, i.e. for Venture Capital funds. An exemplary project shows the following data:

A VC fund purchased the target company on 1.1.2020 for a price of €300k at a Price/EBIT-multiple of 7.5x. 40% of the purchase price is funded by equity of the VC, remaining amount by bank loan at an interest of 10% p.a., collateralized by the shares of the target company. The loan will be repaid on 31.12.2023, accrual for loan repayment is planned pro rata annually. All cash flows related to the purchase will be pushed down into the target company’s P&L.

The target company runs operationally at annual revenues of €150k in 2020, growing each upcoming year at 4%, while operational costs in 2020 are at €-110k at a future growth rate of 2% year-on-year. In 2020, EBIT is €40k. Operational interest is at €-6.0k (and will be stable for the upcoming years). Tax rate is 30%. There are no other operational P/L impacts.

The VC plans to sell the company on 31.12.2025 (= after 6 years) at a Price/EBIT-multiple of 7.5x which was the same at purchase.

Please complete the financial model of the transaction based on the xls-table below. In case of lack of data, please take a reasonable assumption for your subsequent calculation. Please calculate the planned annual profitability of the VC fund and the overall internal rate of return. As the financing bank, what is your recommendation in respect to the transaction and its risks and benefits?

Transaction data

Purchase price 300€

Equity 120€

Debt capital 180€

Term dept 4 years bullet repayment

Annual debt accrual 45.0€

Interest rate 10.0%

Tax rate 30%

Target company 2020 2021 2022 2023 2024 2025

Revenues 150,0

Cost operational -110,0

EBIT 40,0

Interest operational -6.0

Taxes -10,2

PBT 23,8

Answer 1

Assumption: Inflation is taken as 0%

Filling the table:

It is given in the question that the revenue is expected to grow at a rate of 4% year on year, the operational remains at 6 and the operational costs grow at 2% year on year. Using these values and the follwing equations the table can be filled as shown above:

EBIT = Revenues - Costs operational

Taxes = 30%*(EBIT-Interest operational)

PBT = EBIT - Interest operational - Taxes

Calculating profit after interest payment to the bank:

The annual debt accrual is given to be €45, which means the company pays the bank €45 (pro rata basis) for the following four years. Subtracting that from the PBT and adding the profits made each year, we get the profit made from the operation of the company.

Reselling of the company:

After 6 years, the company is resold at 7.5 times the EBIT, which is €457.87.

Overall profit:

Overall profit can be calculated as follows:

Overall profit = Price of reselling + Operational Profit - Cost of Buying

This is assuming the interest paid to the bank is subtracted from the operating profit.

We can see that the overall profit is €163.4 or 1.36 overall internal rate of return. (Calculated as = Profit/Amount invested)

Advice as the financing bank:

The transaction made is profitable as we can see it gives us a return of 50% over 6 years, but there are risks involved in terms of handling the operations of a company, high amount of investment is required if any failure occurs, also the company is not profitable in the first four years while repaying the interest, if other sources of income do not exist, the shares held as collateral by the bank are at risk thus affecting the parent company. measures need to be taken to ensure the health and operation of the company before purchase. If the operations of the company fit the profile of the parent company, considering the growth of revenue compared to the operational costs, the company will provide operational profits over the years and can be considere for holding instead of selling.