105: Traditional Private Equity

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If you have at least $2 million of annual EBITDA, you are a candidate for traditional private equity. There are two general types of private equity transactions: Control Buyouts and Minority Investments. 

Control Buyouts

These can be divided into two subtypes: (a) majority recapitalizations (“majority recaps”) or (b) full buyouts. Full buyouts are rare and are generally only interesting to PE in special situations. Usually, if you want to sell to PE, you’ll have to tell a story about all the growth initiatives in the business. If you tell that story, but don’t want to keep chips on the table, they’ll wonder why.

Majority recaps are, in my opinion, a great option for an entrepreneur who wants to: (a) get his or her name off the personal guarantee of the debt, (b) wants to diversify personal wealth, and (c) keep chips on the table, but take advantage of leverage (illustration below). Note, the amount you keep on the table is called the “Rollover,” and you’ll see below that you basically Rollover 1/8 of your proceeds from the sale, but you get to own 1/4 of the company going forward.

This is because the red blocks represent the equity of the company. You and the PE firm are equally advantaged by the debt, but it really falls in your favor. The best part is that your name is no longer on the guarantee for the loan, so you’ve diversified your wealth, you still own a big piece of your favorite asset, and there is now a significant wall between you and the risk at your company.

Sound too good to be true? So long as you and your make sure you negotiate that your equity will be pari passu (Latin for “side by side”), the buyer’s borrowing is to your benefit. Pari Passu is a legal term, meaning you have the same security. You can’t always get pari passu, but you should at least do the math to make sure your equity is still worth a lot.

For more on how PE structures Minority Investments, refer to 103: Venture Capital & Growth Private Equity.

Click here to read 106: Investment Banks.

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