Deck 13: Financing the Deal: Private Equity, hedge Funds, and Other Sources of Funds

Question 1

Accounts receivable represent an undesirable form of collateral from the lender's point of view because they are often illiquid.

Answer 1

False

Question 2

LBO investors often use public offerings of the firm's stock or sell the firm to a strategic buyer in order to exit the business.

Answer 2

True

Question 3

LBO investors seldom sell assets to repay debt used to acquire the firm.

Answer 3

False

Question 4

Financial buyers usually hold onto their investments for at least 15-20 years.

Question 5

Loan agreements commonly have cross-default provisions allowing a lender to collect its loan immediately if the borrower is in default on a loan to another lender.

Question 6

LBO investors will often use the target firm's cash in excess of normal working capital requirements to finance the transaction.

Question 7

When a public company is subject to a leveraged buyout,it is said to be "going private."

Question 8

A negative loan covenant is a portion of a loan agreement that specifies the actions the borrowing firm agrees to take during the term of the loan.

Question 9

Premiums paid to LBO target firm shareholders often exceed 40%.

Question 10

LBO capital structures are often very complex,consisting of bank debt,subordinated unsecured debt,preferred stock,and common equity.

Question 11

The high premiums paid to LBO target shareholders reflect the tax benefits associated with the high leverage of such transactions and the improved operating efficiency following the completion of the buyout resulting from management incentive plans and the discipline imposed by the need to repay debt.

Question 12

A leveraged buyout initiated by a firm's management is called a management buyout.

Question 13

Investors in LBOs are frequently referred to as financial buyers,because they are primarily focused on relatively short-to-intermediate-term financial returns.

Question 14

Junk bonds are high-yield bonds either rated by the credit-rating agencies as below investment grade or not rated at all.

Question 15

High growth firms with high reinvestment requirements often make attractive LBO targets.

Question 16

Leveraged buyout firms use the unencumbered assets and operating cash flow of the target firm to finance the transaction.

Question 17

According to fraudulent conveyance laws,if a new company is found by the court to have been inadequately capitalized to remain viable,the lender could be stripped of its secured position in the assets of the company or its claims on the assets could be made subordinate to those of the general creditors.

Question 18

Because of their high liquidity,lenders often lend up to 100% of the book value of accounts receivable pledged as collateral in leveraged buyouts.

Question 19

Typical LBO targets are in mature industries such as manufacturing,retailing,textiles,food processing,apparel,and soft drinks.

Question 20

Investors in highly leveraged transactions who are primarily focused on relatively short-to-intermediate term financial returns are often called financial buyers.

Question 21

Firms with redundant assets and predictable cash flow are often good candidates for leveraged buyouts.

Question 22

Financial buyers usually plan to hold onto acquired firms longer than strategic buyers.

Question 23

Under-performing operating units of large companies are often excellent candidates for LBOs.

Question 24

Fraudulent conveyance laws are intended to prevent shareholders,secured creditors,and others from benefiting at the expense of unsecured creditors.

Question 25

Borrowers often prefer term loans because they do not have to be concerned that these loans will have to be renewed.

Question 26

Junk bonds are always high risk.

Question 27

A term loan usually has a maturity of less than one year.

Question 28

Borrowers often seek revolving lines of credit that they can draw upon on a daily basis to run their business.

Question 29

The loan agreement stipulates the terms and conditions under which the lender will loan the firm funds.

Question 30

Junk bonds have invariably proved to be a reliable source of low-cost financing in LBO transactions during the last 30 years.

Question 31

Divisions of larger companies are generally poor candidates for successful leveraged buyouts.

Question 32

Asset based lending does not require the borrower to pledge assets as collateral underlying the loans.

Question 33

To avoid being subject to fraudulent conveyance laws,a properly structured LBO should have a balance sheet that clearly indicates solvency at the time of closing.

Question 34

Asset based lenders will usually lend up to 100% if the book value of the LBO target's receivables.

Question 35

An affirmative covenant is a portion of a loan agreement that specifies the actions the borrowing firm cannot take during the term of the loan.

Question 36

Common exit strategies for LBOs include sale to a strategic buyer,an IPO,a leveraged recapitalization,or a sale to another buyout firm.

Question 37

The risk associated with overpaying is magnified for leveraged buyout transactions.

Question 38

A single asset is often used to collateralize loans from different lenders in LBO transactions.

Question 39

The loan agreement stipulates the terms and conditions under which the lender will loan the borrower funds.

Question 40

Cash flow lenders view the borrower's future cash flow generation capability as the primary means of recovering a loan,while largely ignoring the assets of the LBO target.

Question 41

The LBO that is initiated by the target firm's incumbent management is called a management buyout.

Question 42

When a public company is subject to an LBO,it is said to be going private,because more than 50% of the equity of the firm has been purchased by a small group of investors and is no longer publicly traded.

Question 43

Bridge financing is usually expected to be replaced within two years after the closing date of the LBO transaction.

Question 44

LBOs can be of an entire company or divisions of a company.

Question 45

Limitations the lender imposes on the borrower on the amount of dividends that can be paid,the level of salaries and bonuses that may be given to the borrower's employees,the total amount of indebtedness that can be assumed by the borrower,and investments in plant and equipment and acquisitions are called affirmative covenants.

Question 46

LBO investors have become much more actively involved in managing target firms in recent years than they have in the past.

Question 47

If the LBO is structured as a direct merger in which the seller receives cash for stock,the lender will make the loan to the buyer once the appropriate security agreements are in place and the target's stock has been pledged against the loan.The target then is merged into the acquiring company,which is the surviving corporation.

Question 48

A common technique used during the 1990s was to wait for favorable periods in the stock market to sell a portion of the LBO's equity to the public.The proceeds of the issue would be used to repay debt,thereby reducing the LBO's financial risk.

Question 49

The growth in LBO activity is not simply a U.S.phenomenon.Western Europe has seen a veritable explosion in private equity investors taking companies private,reflecting ongoing liberalization in the European Union as well as cheap financing and industry consolidation.

Question 50

Preferred stock often is issued in LBO transactions,because it provides investors a fixed income security,which has a claim that is junior to common stock in the event of liquidation.

Question 51

LBOs may be consummated by establishing a new subsidiary that merges with the target.This may be done to avoid any negative impact that the new company might have on existing customer or creditor relationships.

Question 52

LBO firms seldom purchase a firm to use as a platform to undertake other leveraged buyouts in the same industry.

Question 53

The acquirer often is asked for a commitment letter from a lender,which commits the lender to providing financing for the transaction.

Question 54

Because term loans are negotiated privately between the borrower and the lender,they are much more expensive than the costs associated with floating a public debt or stock issue.

Question 55

There is some evidence that the Sarbanes-Oxley Act of 2002 has also been a factor in some firms going private as a result of the onerous reporting requirements of the bill.

Question 56

An indenture is a contract between the firm that issues the long-term debt securities and the lenders.

Question 57

If the borrower defaults on the loan or otherwise fails to honor the terms of the agreement,the lender can seize and sell the collateral to recover the value of the loan only if the borrower agrees that it is unlikely that the loan will be repaid.

Question 58

Debt issues not secured by specific assets are called debentures.

Question 59

Secured debt often is referred to as mezzanine financing.

Question 60

The promissory note commits the borrower to repay the loan,only if the assets when liquidated fully cover the unpaid balance.

Question 61

LBO investors must be very careful not to overpay for a target firm because

A) Major competitors tend to become more aggressive when a firm takes on large amounts of debt
B) High leverage increases the break-even point of the firm
C) Projected cash flows are often subject to significant error limiting the ability of the firm to repay its debt
D) A and B only
E) A, B, and C

Question 62

Premiums paid to LBO firm shareholders average

A) 20%
B) 70%
C) 5%
D) Less than typical mergers
E) More than typical mergers

Question 63

Asset based lending is commonly used to finance leveraged buyouts.Which of the following is not true about such financing?

A) The borrower generally pledges tangible assets as collateral.
B) Lenders look at the target firm's assets as their primary protection.
C) Bank loans are secured frequently by receivables and inventory.
D) Loans maturing in more than one year are often referred to as term loans.
E) The target firm's most liquid assets generally secure longer-term loans.

Question 64

Which of the following tends to be true of LBOs

A) LBOs rely heavily on management incentives to improve operating performance
B) The premium paid to target firm shareholders often exceeds 40%
C) Tax benefits are predictable and are built into the purchase price premium
D) The cost of equity is likely to change as the LBO repays debt
E) All of the above

Question 65

Factors that are most likely to contribute to the magnitude of premiums paid to LBO target firm shareholders are

A) Tax benefits
B) Improved operating efficiency
C) Improved decision making
D) A, B, and C
E) A and C only

Question 66

Which of the following is not true about junk bonds?

A) Junk bonds are either unrated or rated below investment grade by the credit rating agencies
B) Typically yield about 1-2 percentage points below yields on U.S. Treasury debt of comparable maturities.
C) Junk bonds are commonly used source of "permanent" financing in LBO transactions
D) During recessions, junk bond default rates often exceed 10%
E) Junk bond default risk on non-investment grade bonds tends to increase the longer the elapsed time since the original issue date of the bonds

Question 67

Which of the following is not true about attractive LBO candidates?

A) Most assets tend to be encumbered
B) Have low leverage
C) Have predictable cash flow
D) Have assets that are not critical to the ongoing operation of the firm
E) Are in mature, moderately growing industries

Question 68

Fraudulent conveyance is best described by which of the following situations:

A) A new company spun off by its parent to the parent's shareholders that enters bankruptcy is found to have been substantially undercapitalized when created
B) An acquiring company pays too high a price for a target firm
C) A company takes on too much debt
D) A leveraged buyout is taken public when its operating cash flows are increasing
E) None of the above

Question 69

Most highly leveraged transactions consist of acquisitions of private rather public firms.

Question 70

Security provisions and protective covenants are included in loan documents to increase the likelihood that the interest and principal of outstanding loans will be repaid in a timely fashion.Which of the following is not true about security provisions and protective covenants?

A) Security features include the assignment of payments due under a specific contract to the lender.
B) Negative covenants include limits on the amount of dividends that might be paid
C) Limitations on the amount of working capital that the borrower can maintain.
D) Periodically, financial statements must be sent to lenders.
E) Automatic loan repayment acceleration if the borrower is in default on any loans outstanding

Question 71

Which of the following is generally not true about leveraged buyouts?

A) Borrowed funds are used to pay for all or most of the purchase price, perhaps as much as 90%
B) Tangible assets of the target firm are often used as collateral for loans.
C) Bank loans are often secured by the target firm's intangible assets
D) Secured debt is often referred to as junk bond financing.
E) C and D only

Question 72

LBO exit strategies involving selling to a strategic buyer usually result in the best price as the buyer may be able to generate significant synergies by combining the firm with its existing business.

Question 73

Management buyouts without a financial equity contributor are relatively rare.

Question 74

Which of the following is generally not considered a characteristic of a financial buyer?

A) Focus on short-to-intermediate returns
B) Concentrate on actions that enhance the ability of target firm's ability to generate cash flow to satisfy debt service requirements
C) Intend to own the business for very long periods of time
D) Manage the business to maximize return to equity investors
E) All of the above

Question 75

Which of the following are commonly used sources of funding for leveraged buyouts?

A) Secured debt
B) Unsecured debt
C) Preferred stock
D) Seller financing
E) All of the above

Question 76

Which of the following is not typically true of LBOs?

A) Managers are generally also owners
B) Most employees are given the opportunity to participate in profit sharing plans
C) The focus tends to be on improving operational efficiency though cost cutting and improving productivity
D) R&D budgets following the creation of the LBO are always increased significantly
E) All of the above

Question 77

LBOs often exhibit very high financial returns during the years following their creation.Which of the following best describes why this might occur?

A) LBOs invariably improve the firm's operating efficiency
B) LBOs tend to increase investment in plant and equipment
C) The only LBOs that are taken public are those that have been the most successful
D) LBOs experience improved decision making during the post-buyout period
E) None of the above

Question 78

LBOs normally involve public companies going private.

Question 79

An investor group acquired all of the publicly traded shares of a firm.Once acquired,such shares would no longer trade publicly.Which of the following terms best describes this situation?

A) Merger
B) Going private transaction
C) Consolidation
D) Tender offer
E) Joint venture

Question 80

Which of the following characteristics of a firm would limit the firm's attractiveness as a potential LBO candidate?

A) Substantial tangible assets
B) High reinvestment requirements
C) High R&D requirements
D) B and C
E) All of the above