Zapalac & Hudgins
The following is a hypothetical scenario whereby Mr. Gary Reasons, the 55-year-old owner of Reasons Cleaning Corp., would recapitalize his company through a leverage recapitalization. Reasons Cleaning was founded in 1987 and provides tank cleaning services to oil and gas companies located in the Gulf Coast region.
Zapalac & Hudgins will market the transaction to 200+ private equity groups. Confidentiality agreements are signed and deal books (Confidential Information Memorandums) are sent out to interested groups. After about 40 days for the private equity groups to review, bids are received back. Ultimately, Mr. Reasons negotiates and accepts one of the groups offers. A letter of intent is drafted and signed between the two parties defining their preliminary understandings and crystallizing in writing the basic terms of the transaction.
The following will show the financial analysis that was used in determining the deal pricing and metrics that ultimately will get signed into the letter of intent. The company generates approximately $10 million of annual EBITDA, or cash flow, and the business is valued at $60 million. or 6x EBITDA (cash flow). The company has $0 of existing debt on its balance sheet. Thus, the net equity value of the company is equal to $60 million ($60 million enterprise value less $0 million debt).
Sources & Uses of Funds
At Close, Mr. Reasons will receive his $60 million of equity value as (i) a $45 million one-time cash dividend payable at closing and (ii) $15 million of “rollover” stock of the newly recapitalized company that is worth 48% percent of the fully diluted common stock going forward. In addition, there is assumed to be $1 million of buyer / due diligence fees.
Financing the transaction will consist of (i) $0 funded Line of Credit ($5MM facility), (ii) $30 million of senior bank debt, (iii) $16 million private equity investment and (iv) the $15 million of rollover stock. Unlike most companies and their existing financing arrangement, there will be no personal guarantees for Mr. Reasons on the debt going forward. Under the leverage recapitalization transaction, a private equity firm who will be investing alongside the transaction typically has the clout with the senior lenders and mezzanine lenders that no shareholders will personally guarantee the newly refinanced debt.
Post-closing for the recapitalization, the capital structure of the company would consist of (i) $30 million of funded debt and $31 million of total equity ($16 million new equity from an equity sponsor plus $15 million rollover equity from the shareholders). Credit statistics are close are 3.0x total leverage and 49%/51% debt to equity ratio. Thus, a conservatively financed capital structure.
Over the next 90 days, Mr. Reasons and certain key personnel, Z&H, attorneys, accountants and lenders all continue to pursue their necessary levels of due diligence to satisfy their internal requirements.
Purchase Agreement & Closing
Negotiating the purchase agreement and closing. Upon successful completion of due diligence, the attorneys for the buyer and the Company will have drafted and negotiated the final terms of the acquisition purchase agreement.
Selling the “Rollover Stock” – 2nd Bite at the Apple
Over the next five years, the Company’s EBITDA increases from $10 million to $12.8 million at the end of the fifth year. The Company is sold at the end of the fifth year to a strategic buyer for the same multiple that it was purchased for, a 6x multiple of EBITDA/cash flow. Thus, the Company increases in value from $60 million (at close) to $76.8 million at the end of the fifth year. During the five-year holding period, the Company uses its free cash flows to repay debt from $30 million at close to $5.6 million by the end of the fifth year. Thus, the net equity value of the chemical division increases from $31 million at close to $71.2 million. Mr. Reasons 48% “rollover” stock has increased from $15 million at Close to $34.3 million at the end of the fifth year. In total, Mr. Reason’s received an upfront payment of $45 million and a 2nd bite of the apple of $34.3 million for a total value received for his Company of $79.3 million.
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