PE Case Study Question
Say you own a business doing $7MM in EBITDA and a PE firms offers to give you the following for 80% of your business:
- $60MM cash
- $7MM earn out paid at the end of year 1 if EBITDA goes up 12% (if hurdle is not met then $0 is earned)
- $15MM seller note that will amortize 5 years from the date of closing with 0% interest
Seller retains 20%
The PE firm plans to borrow 4x at a 5% blended interest.
What is the approximate total value of this transaction (including the value of their retained equity)?
ALSO
#2 You have the chance to recommend two deals to your portfolio manager, which do you choose (assume both are guaranteed outcomes)
- Buy a growing company where more employees are hired over time and the company is taken to the next level. Due to the higher purchase price, your IRR on this investment is 25%.
- Buy a distressed company that has a good chance with help of turning around, but your plan is instead to immediately fire everyone and liquidate the company. Because of the low purchase price, your IRR on this investment is 40%.
Would need some more clarity on the second question. How can you purchase the second company for such a steep discount that it would lead to a 40% IRR after immediate liquidation? The company has to be somewhat levered to be distressed, right? Assuming this is a fixed asset-heavy business (for simplicity's sake), is it being sold for that much below book value that you could earn that magnitude of a return simply from flipping the assets? If the assets are that valuable in the market vs. the potential sale to you, why doesn't the current ownership pursue that path and just use the proceeds to pay creditors?
In any case, without knowing the MOIC or amount of capital you could deploy, what is the reason against picking the 40% IRR scenario if both are guaranteed (outside of maybe social optics / firm reputational damages that may be associated with the distressed play)? You would get cash returns quicker, and if you chose the growing company your capital would likely be tied up for 3-5 years to grow into an exit. The second scenario just seems a little too good to be true unless I'm stupid and misreading something.
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