The phrase “M&A” is often associated with selling your business. But, what if you’re not looking to sell? What if your business is poised for growth? You may not be looking for an exit right now, but taking on ALL the risk and expense, may give you pause. If this sounds familiar, then the 2-Step transaction may be right for you.
A 2-Step transaction is usually good when the business is reasonably healthy, with good prospects for growth, and top management is excited to lead. The 2-Step solves some common problems, such as:
- You would like a partner to help share the risks and investments of growth.
- You don’t want to exit completely, but would like to lock in the good market valuations and take some chips off the table now.
- You would like to grow the company with OPM (other people’s money), perhaps doing some add-on acquisitions for faster growth.
- The business can benefit from sophisticated partners in financial matters, operations support and at the board level.
Financially, a 2-Step transaction can be very lucrative. The idea is to sell a stake in the company now, grow the company with the private-equity partner, then have another transaction in the future. In most cases, the “second bite at the apple” is bigger than the first, thanks to the company’s growth and the use of leverage in the transaction.
For example, let’s say your business is currently at $15M in revenue, with a 20% EBITDA margin. Perhaps the market would apply a 5X multiple, making the Enterprise Value $15M.
In the first step of the transaction, the private equity group might buy 70% and you keep 30%. They may use a modest level of 2X debt, or $6M. You benefit from this debt, making the cost of your new 30% only $2.7M. The gross proceeds to you from selling 70% is $12.3M.
By working with the buyer, using their funds and sophisticated team, you grow the business, perhaps through some add-on acquisitions, and in 5 years time, the business has doubled. It is now doing about $30M in revenue with a slightly improved EBITDA margin of 25%.
In the second step of the transaction, the market applies a 6X multiple to this larger business, and the Enterprise Value is now $45M. By this time, the debt is gone and your 30% is worth $13.5M, more than the original 70%. Your total consideration is $25.8M.
Everyone’s situation is different and this example is just an illustration. But if this sounds interesting, then talk to one of the CFA professionals and see if this is right for you.
Posted by Dan Vermeire.