Operating partners talk in margin points and investment committees think in multiples of money, and the conversion runs through exit revenue, not entry revenue.
One point of EBITDA margin is worth exit revenue, times one per cent, times the exit multiple, plus the after-tax cash it earns while the fund owns the company. On an illustrative company with 176.3 of exit revenue sold at 10.0x, one point adds 1.76 of EBITDA and 17.63 of equity value at exit, 0.18x on a 100.0 cheque. Counting the cash earned on the way and the cost of getting there, the point is worth 21.35 and moves the deal from 2.24x to 2.46x.
Worked in full in The Private Equity Operating Partner by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Margin is the language of the value creation plan: procurement takes out half a point, pricing adds one, a shared service centre adds another. The investment committee, though, approved a multiple of money. Translating one into the other is simple, but the version most decks use applies the point to the wrong revenue and quietly mixes recurring and one-off gains.
| Input | Value |
|---|---|
| Revenue at entry | 120.0 |
| EBITDA margin at entry | 15% |
| EBITDA at entry | 18.0 |
| Entry and exit multiple | 10.0x |
| Debt at entry | 80.0 |
| Equity cheque | 100.0 |
| Revenue growth a year | 8% |
| Hold | 5 years |
| Net debt at exit, base plan | 40.0 |
| Tax rate on extra EBITDA | 25% |
| One-off cost to achieve the point | 2.0 |
In the base plan revenue grows to 176.3 in year five, EBITDA at 15 per cent is 26.45, enterprise value at 10.0x is 264.5 and, after 40.0 of net debt, equity is 224.5: a 2.24x multiple and an IRR of about 17.6 per cent.
Exit value of a margin point = exit revenue × 1% × exit multiple
Total value = exit value + Σ (revenuet × 1% × phasingt) × (1 − tax) − cost to achieve × (1 − tax)
In Excel: =Rev_Exit*Margin_Uplift*Exit_Multiple+SUMPRODUCT(Rev_Path,Phasing)*Margin_Uplift*(1-Tax)-CTA*(1-Tax)
Step 1, the exit value. One point on 176.3 of revenue is 1.76 of EBITDA. At 10.0x it is 17.63 of enterprise value, and since debt does not change, 17.63 of equity: 17.6 per cent of the cheque, or 0.18x.
Step 2, the cash during the hold. The point is phased in: half in year one, all of it from year two. Revenue runs 129.6, 140.0, 151.2, 163.3 and 176.3, so the extra EBITDA is 0.65, 1.40, 1.51, 1.63 and 1.76, a total of 6.96. After 25 per cent tax that is 5.22 of cash, which repays debt and lands in exit equity. Interest saved on that debt is ignored, so this slightly understates the cash.
Step 3, the cost. The programme costs 2.0 once, 1.50 after tax.
Result. 17.63 + 5.22 − 1.50 = 21.35 of equity value. Exit equity rises from 224.5 to 245.8, the multiple from 2.24x to 2.46x, and the IRR from about 17.6 to 19.7 per cent. Of the gross value, 77 per cent comes from the exit multiple and 23 per cent from cash earned during the hold.
A point of margin is a large EBITDA change. On a 15 per cent margin, one point is 6.7 per cent more EBITDA. Matching it through growth alone would take 11.8 of extra exit revenue at the existing margin.
Leverage does not change the value of the point, only how large it looks against the cheque. The 17.63 is enterprise value, and it falls entirely to equity whatever the debt. Had the same company been bought with 120.0 of debt and a 60.0 cheque, the same point would be worth 0.29x of money rather than 0.18x. That is why margin plans in highly levered deals look more powerful in multiple terms: the operating work is identical, the denominator is smaller.
| Margin uplift | Exit EBITDA added | At 8.0x | At 10.0x | At 12.0x |
|---|---|---|---|---|
| 0.5 points | 0.88 | 7.1 | 8.8 | 10.6 |
| 1.0 point | 1.76 | 14.1 | 17.6 | 21.2 |
| 2.0 points | 3.53 | 28.2 | 35.3 | 42.3 |
| 3.0 points | 5.29 | 42.3 | 52.9 | 63.5 |
Value is linear in both the points and the multiple, which makes the table a quick test of a value creation plan. If the plan needs 0.5x of extra money multiple from margin on this cheque, it needs about three points at 10.0x and more than three at 8.0x. A plan that leans on margin and also assumes a lower exit multiple than entry should show both in the same table.
Price every margin initiative on exit revenue at the exit multiple, then add the after-tax cash it earns while you own the company and subtract its cost. On this case one recurring point is worth 21.35, about 0.21x of money multiple. The value creation bridge in the free workbook for this book shows how those operating gains reconcile with growth, multiple and deleveraging at exit; to split a realised exit the same way, see how to split EBITDA growth and multiple expansion.
Because the point applies to the revenue the buyer acquires, not the revenue the fund bought. On an illustrative company growing 8 per cent a year, revenue rises from 120.0 to 176.3 in five years, so one point is 1.76 of EBITDA at exit, against 1.20 at entry. At 10.0x that is 17.63 of value, not 12.0.
On an illustrative 100.0 equity cheque, 176.3 of exit revenue and a 10.0x exit multiple, each point adds 17.63 of exit equity, about 0.18x. Three points add 52.9 of value at exit, roughly 0.53x, before hold-period cash. At an 8.0x exit three points add 42.3 and fall short.
Not the same, but it can be converted. At a 15 per cent margin, one point of margin on 176.3 of exit revenue adds 1.76 of EBITDA, the same EBITDA as 11.8 of extra revenue at the existing margin. One point of margin is 6.7 per cent more EBITDA.
This article is one calculation from The Private Equity Operating Partner. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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