Posted: June 1st, 2021

Sample LBO Model

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What is an LBO?
LBO occurs when a company acquires a controlling interest in another company using mostly debt to finance the purchase. The acquired are mostly used as collateral for the debt being used to finance the transaction by the target’s own assets .The leveraged buyouts aims to allow companies to make large acquisitions without requiring a lot of capital.

What is a tender offer?
Tender offer denotes when an offer is publicly made to the shareholders of a publicly traded company to tender some or all of their shares. It can be offered by 3 ways: open offer, public, or invitation. It is usually made at a premium price to the market price and will exist for a finite period of time.
In general (i.e. not specific to the RJR Nabisco case), what is the agency problem between stockholder and mangers?
Agency problem arises between stockholders and manger when there is a conflict of interest between the needs of the principal and the needs of the agent and it is associated with firm value and financial leverage. Acting as an agent for the shareholders, the managers make decisions that will maximize their own wealth instead of the shareholders’ wealth. It is possible to eliminate the agency problem completely; however, to minimize this problem a manager can be motivated to act in the shareholders’ best interests through incentives and managing their financing debt.
Describe some of the agency problems that existed at RJR Nabisco (i.e. Rat hole investment perk consumption, etc.).
In order to be more cost effective and efficient RJR Nabisco’s LBO maintained a company air force of 10 crafts. However, the managers overused and abused the corporate’s aircrafts for their own personal use, when the shareholders were not capable on monitoring them. This case is an example of perk consumption.Ross Johnson, Nabisco’s chief executive, after leveraged buyouts refused to give up the company’s air force. This action created a big problem as the excessive consumption suggested that the executives were les protective on the assets and it showed weak governance which result an underperformance over time. Another agency problem is that the executives had spent $10 million on equipment that could be bought by a much lower cost. In fact, buying unnecessary subsidiaries creates an agency problem.
How might an LBO mitigate some of the agency problems that excited?
LBO mitigate these agency conflicts by allowing managers to own a larger stake in the firm since agency problem arises when a firm’s manager is not a 100% owner of the equity, so he/she has incentives to invest in negative NPV projects including consumption of excessive
perks(Jensen and Meckling 1976). An increase of a firm leverage increase managerial equity as well. This implies that the manger’s equity interest is not sold by the manager which is result into intensives for the managers to operate the firm effectively and reduce investment costs. Also, the managers become more aware and not wasting resources when debt interest is monitored by the buyout specialist.
Whose interests are supposed to be represented by the board of directors?
The interests of the shareholders are represented by the Board of Directors, so the shareholders have no responsibility in term of supervising the company. The board of directors is the highest governing authority within the management structure at any publicly traded company.
Why didn’t the RJR Nabisco board of directors establish some stricter ground rules for the LBO bid process, just to make its own job easier?
RJR Nabisco board of directors did not establish some stricter ground rules for the LBO bid process because it believed that by establishing their rules, this would lead to a bidding war among the bidders. As result, the value would keep rising, and they could sell the highest value of shares to the bidder.

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