Case Study Overview 

• Scenario: Transition from W2 Executive to PE Portfolio Partner Level
• Company Profile:
• Equity Offered: 5% ownership
• Current Equity Value: $2M
• PE Firm’s Expectation: 3x – 10x cash on cash return over 5 years

• Sales: $100M

·       EBITDA: $10M

·       Growth Goal: Increase EBITDA to $50M

Understanding Equity in PE

1.      Nature of Equity:

2.      Value Growth:

3.      Risk and Reward

W2 Executive: Compensation is mainly salary and bonuses. Bonuses may be tied to performance, but they do not provide ownership or long-term stake in the company.

PE Partner Level: Equity implies ownership. Your 5% equity means you own a part of the company, and your financial fortunes are tied to the company’s performance.

Regular Jobs: Salary and bonuses might increase with inflation (capped at 5%) or promotions, but they are generally predictable and have a cap.

PE Equity: The value of equity is tied to the company’s value. If the company grows from $10M to $50M EBITDA, the overall value increases significantly, potentially boosting the value of your equity stake.

W2 Role: Lower risk as salary is guaranteed, but limited upside.

PE Equity: Higher risk (equity could become worthless if the company fails) but higher potential reward.

Financial Projection

Assuming the company achieves the targeted EBITDA growth:

• Initial Valuation: If your 5% equity is valued at $2M, the total company valuation is $40M ($2M is 5% of $40M).
• Targeted Growth: Increase EBITDA to $50M.
• Future Valuation: Using the same valuation multiple, if EBITDA grows 5x, the company’s valuation could also increase significantly. However, the exact multiple depends on market conditions, the company’s performance, and other factors.

Potential Earnings in 5 Years

• Conservative Scenario (3x Return): If the company’s valuation triples, your 5% could be worth 3x of $2M = $6M.
• Optimistic Scenario (10x Return): In a more optimistic scenario, a 10x return would make your stake worth $20M.

Key Differences and Considerations

·       Control and Influence: As a PE partner, your decisions directly impact your financial outcome.

·       Time Horizon: Equity usually has a longer-term focus compared to annual bonuses.

·       Exit Strategy: The PE firm’s exit strategy (e.g., selling the company, IPO) will significantly influence when and how you can liquidate your equity.

·       Vesting and Clauses: Understand any vesting schedules or clauses that might affect your ownership.

Conclusion

The transition from a W2 executive role to a PE partner level with equity involves a shift from a steady, predictable compensation model to one with higher risk but potentially higher rewards. It’s essential to understand the company’s growth trajectory, market conditions, and your own risk tolerance when evaluating such an opportunity.