A $400M high-yield bond in an LBO has non-call 3, then callable at 104.5 in year 4, 102.25 in year 5, and par thereafter. The sponsor is considering an exit at the end of year 2 and at the end of year 4. For each exit timing, explain how the bond is treated in the exit enterprise value to equity bridge. If the sponsor wants to deliver the company debt-free to a buyer in year 4, what additional cash cost is incurred?

Answer:
For a year 2 exit, the bond is within its non-call period and cannot be prepaid at par without potentially incurring a large make-whole premium. In the model, the bond is assumed to remain outstanding and is subtracted from exit EV (along with any other debt) to arrive at equity proceeds. The buyer acquires the company subject to that debt.

For a year 4 exit, the bond becomes callable at 104.5% of par. If the sponsor wishes to extinguish the bond to deliver a debt-free company, it must pay $400M × 1.045 = $418M, a premium of $18M. This premium reduces equity proceeds dollar-for-dollar. The cost is modeled as an additional use of cash at exit: exit net debt = TLB + bond redemption cost (not face value). The equity value under a debt-free sale is (EV minus TLB minus $418M) rather than (EV minus TLB minus $400M). A buyer would adjust the purchase price accordingly.

Follow-up pressure:

1. "What is the typical rationale for a sponsor to sell a company with the existing debt in place rather than redeeming it? How does this affect the buyer's financing?"
2. "If the bond was trading at 95 in the secondary market in year 4, how could the sponsor take advantage of that to reduce the exit cost? What are the practical limitations?"
3. "Explain what an equity clawback provision is and how it could allow early partial redemption of the bond even during the non-call period."