Why is the floor of an LBO important?

• A. It defines the maximum price the financial sponsor can pay
• B. It determines the minimum return on investment expected
• C. It demonstrates the projected cash flows
• D. It signifies the potential for operational improvements

Answer: (B)

The importance of the floor in a leveraged buyout (LBO) primarily pertains to the minimum return on investment that the financial sponsor expects. In financial modeling for an LBO, the floor represents a baseline level of returns that investors require to justify the risk of the investment. This minimum return is crucial as it influences several strategic decisions, including the maximum price that can be paid for the target company and the debt structure to be utilized.

Establishing a clear floor ensures that the investment is not only viable but also attractive relative to other opportunities available in the market. Additionally, it serves as a guide for the performance metrics that need to be met to achieve desired outcomes. By understanding the floor, sponsors can better assess the feasibility of the deal and make informed predictions about how operational improvements and cash flows can be optimized to meet or exceed this return threshold.