As a result of qualifying for round-two, the strategic buyer was given access to the acquisition candidate's management and records and, based on that input and analysis, revised the round-one forecast to fit its (the strategic buyer's) outlook for the business. The question at that point was: what should the strategic buyer's final bid be, knowing that its investment hurdle rate (required pretax rate of return); sources of acquisition funds; and debt recourse obligations are very different from those of the usual private equity buyer?
To calculate the suggested round-two strategic buyer purchase price bid I used the Corpfin.Net LBO model and reset the required pretax rate of return target and the cost of those funds. Specifically, I set the required rate of return on both equity and subordinated debt to equal the strategic buyer's hurdle rate; and set the current-pay interest rate on subordinated debt to 0%.
The revised required rates of return assumptions reflect the reality that all strategic buyer acquisition funding in excess of senior bank debt is equity investment (due to use of corporate cash and/or debt with recourse provisions to accomplish the acquisition).
The zero current-pay interest rate assumption on subordinated debt ensures that all cash generated by the acquired business is taxable and either reduces senior debt or is invested with a return equal to the senior debt interest rate. This assumption eliminates the optimistic assumption in some analysis methods that cash generated by an acquisition's operations is reinvested at the (higher) investment hurdle rate.
The round-two purchase price bid resulted in the strategic buyer being asked to participate in final sale negotiations.