Full lesson
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Borrowed funding makes equity the residual claim
Investors can fund only part of a purchase, yet they receive what’s left after debt is repaid at sale. That leftover is equity, so borrowing can magnify how changes in company value affect investors.
£100m purchase: £60m debt, £40m equity
At the £100 million purchase, debt is borrowed money, and equity is the investors’ own money. With 60 percent financed by debt, that’s £60 million borrowed and £40 million invested by investors. Together, they fund the full purchase price.
Chart values
| Funding source | £m |
|---|---|
| Debt | 60 |
| Investor equity | 40 |
Assumed five-year debt paydown
The debt balance falls from £60 million at purchase to £40 million at the year-five exit. The assumption is that £20 million of cash left after interest, taxes, and investment repays borrowing over those five years.
Chart values
| Time | £m |
|---|---|
| Purchase | 60 |
| Year 5 exit | 40 |
Paydown alone raises the investor's exit proceeds
With annual EBITDA at £10 million and the exit multiple at ten times, company value stays at £100 million. Subtract £60 million of debt, and equity proceeds are £40 million; subtract £40 million, and they’re £60 million. Debt paydown alone adds £20 million.
Chart values
| Debt at exit | Equity proceeds, £m |
|---|---|
| £60m debt | 40 |
| £40m debt | 60 |
Growth adds value even at the same multiple
EBITDA means earnings before interest, taxes, depreciation, and amortization, a rough operating-earnings measure. At £10m annual EBITDA, a 10-times exit multiple gives £100m company value; less £40m debt leaves £60m. At £12m annual EBITDA, the same multiple gives £120m value; less £40m debt leaves £80m.
Chart values
| Annual exit EBITDA | Equity proceeds, £m |
|---|---|
| £10m EBITDA | 60 |
| £12m EBITDA | 80 |
If exit company value stays at £100m, what happens to investor proceeds when debt falls from £60m to £40m?
Let's think this through. If exit company value stays at £100m, what happens to investor proceeds when debt falls from £60m to £40m? A: They rise from £40m to £60m. B: They stay at £40m. C: They fall from £60m to £40m. Choose an answer, or just think it through. I'll explain in a moment.
- They rise from £40m to £60m
- They stay at £40m
- They fall from £60m to £40m
If exit company value stays at £100m, what happens to investor proceeds when debt falls from £60m to £40m?
The answer is A: They rise from £40m to £60m. Investors receive what remains after exit debt is paid. With the same £100m company value, subtracting £40m of debt instead of £60m leaves £20m more for them; the company itself has not become more valuable in this comparison.
- They rise from £40m to £60m
- They stay at £40m
- They fall from £60m to £40m
The buyer's exit multiple changes the sale price
With year-five annual EBITDA fixed at £12 million and debt at £40 million, the exit multiple changes company value: eight times gives £96 million, ten times £120 million, and twelve times £144 million. After debt, equity proceeds are £56 million, £80 million, and £104 million.
Chart values
| Exit EBITDA multiple | Equity proceeds, £m |
|---|---|
| 8 times | 56 |
| 10 times | 80 |
| 12 times | 104 |
£80m exit equity ÷ £40m invested = 2 times money
£80 million is twice the £40 million equity over five years, before fees; lower exit multiples reduce proceeds.
Company value minus remaining debt
Investor exit proceeds equal exit company value minus remaining debt. Company value depends on EBITDA and the exit multiple; debt magnifies equity outcomes, including losses. Debt paydown, growth, and exit pricing shape the residual.