A private equity fund values companies on the basis of a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). To assist you with the basics of most private equity deals, let’s use a “three layer cake” analogy consisting of senior debt, mezzanine debt, and private equity.
This structure is the most commonly used in private equity investment. This structure is generally used in a leveraged buy-out or a change in control transaction because it allows the private equity fund to leverage his down payment to purchase the target company. As you will see, each layer is different and has its own unique characteristics and each layer has its own risk/reward profile.
- Layer 1 – Senior Debt – Low risk, low cost, short term, least flexible.
- Layer 2 – Mezzanine Debt – Moderate risk, moderate cost, long term, flexible.
- Layer 3 – Equity – High risk, high cost, long term, most flexible
Just because a 3-layer cake structure is the most common structure does not mean that it is the only structure that can be used. Most brokers promote private equity oriented deals because they are most common. However, unless you are interested in selling 100% of your company, private equity investment is generally not the proper approach.
Each layer of capital can be used on its own or in conjunction with other layers in varying degrees for any given transaction. There is no rule that requires private equity to be used in every transaction nor is there a rule that requires senior debt or mezzanine debt to be used in every transaction.
Each of these layers has advantages and disadvantages and can be mixed and matched to fit the unique needs of each business. Private equity is the most expensive form of capital and the most control oriented. Private equity investment, unless structured as a minority investment, will result in a sale of the company. Mezzanine debt, as a hybrid form of capital, is a balanced form of high-value capital.
Through understanding these basic rules and structuring technology, we are able to help business owners design optimized structures that meet their needs, as opposed to the needs of the private equity investor. Instead of using the traditional three-layer cake structure that can be expensive and complicated, Attract Capital has created a streamlined, two-layer cake structure. This structure provides flexible, long-term capital at a significant discount to the 3-layer cake structure. It allows us to provide our clients flexible long-term capital for growth, without having to sell their company to a private equity fund.
Contact us today for a FREE consultation on your Private Equity funding solution!