PRIVATE EQUITY | DEMYSTIFY
9
co-invest. Therefore, a PE house will do what it can to make sure that it really understands the risk that it is taking on, which it then tries to mitigate. Mitigation strategies include: paying less, carrying out extensive due diligence and structuring (earn-outs, preferences etc). Typically, PE loan notes have a liquidation preference to (ie gets paid out before) the ordinary equity. Sometimes, the PE house will look to negotiate that their loan notes are prior ranking to the vendor’s and the management’s loan notes. HOW PRIVATE EQUITY MAKES MONEY As time progresses, all being well, the business and its EBITDA grow, bank debt is paid off or amortised, the operations of the business are improved and the Enterprise Value (EV) will increase. This drives value into the ordinary shares (equity value), provided that the EV growth outstrips the total cost of debt and of the loan notes. There is further growth in equity value if there is ‘multiple accretion’, ie if the exit multiple exceeds the entry multiple. As you would imagine, executives in PE houses not only focus on growth of the EBITDA but also in all those things that might positively affect multiples. This will include keeping a weather eye on the market and the timing of any exit. If everyone has done their job well and timing is picked well and the business has been prepared for the sale process well, the returns can be excellent for the fund, the PE house, its executives, the rolling vendors and the management team.
DRIVING VALUE INTO ORDINARY SHARES
£m 100
£10.6m
£42.4m
£200k
50 49
£800k
10%
LOAN NOTES £24m
£32m
25
DEBT £25m
£15m
0
year 0
year 3
EBITDA
£5m
£10m
MULTIPLE
10x
10x
EV
£50m
£100m
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