If you’re just getting your first exposure to the world of private equity, you might have come across the term “turn” and wondered what it means. Simply put, a turn refers to a company’s EBITDA in relation to a multiple. But what does that really mean? Let’s break it down.
Understanding Multiples in Private Equity
First, let’s quickly get up to speed on multiples — what they are and how they’re used.
A multiple is simply a ratio between two figures, such as the company’s enterprise value and its EBITDA (a proxy for earnings).
In private equity (or investment banking, etc.), the value of a company is often measured by a multiple.
For example, in the context of valuation, by multiplying a company’s EBITDA by a multiple, we arrive at the company’s enterprise value (EV). For example, if a company has an EBITDA of $10 million and a multiple of 5.0x, its enterprise value would be $50 million ($10 million x 5). In this example, we just walked through an application of the the EV / EBITDA multiple.
It’s important to note that the multiple used can vary depending on the context. For instance, the entry multiple is the multiple used to value a company at the time of purchase, while the exit multiple is the multiple used to determine the company’s EV at the time of sale.
Another important multiple is the leverage multiple, which is the amount of debt a company has in relation to its EBITDA. This multiple is often used to assess a company’s debt capacity when determining financing at entry (part of your sources & uses).
So, what does that have to do with turns in private equity?
A turn simply refers to an increase, or decrease, of 1.0x on the multiple.
For example, if you’re running the model and your VP tells you to increase your exit multiple by half a turn — if you previously had a 5.0x exit multiple, your new multiple would be 5.5x. In this case, the 0.5x is your half turn.
Or, if you’re raising debt in an LBO, your VP could tell you he thinks your target’s leverage profile won’t support the debt quantum you initially modeled. Instead, he wants you to decrease debt by a full turn. In this case, if you had previously modeled leverage of 5.0x, your new leverage multiple would be 4.0x. In this scenario, the 1.0x decrease in leverage is your full turn difference.
You can also reframe this to look at the turn in terms of the quantum. For example, assuming the target has $100 million of EBITDA, the previous 1.0x full turn decrease in debt would equate to a reduction of $100 million in your amount of debt financing. In this case, a full turn is $100 million and a half turn would be $50M ($100 million of EBITDA x 0.5).
Different Types of Multiples in Private Equity
Remember, a turn can refer to any multiple and can be used in a variety of contexts. The three most common multiples to know will be your entry multiple, your exit multiple, and your leverage multiple. All of these multiples are based on a company’s EBITDA and the concept of a turn will be applied in the same way for each. Here’s a full breakdown:
That’s It
It’s a simple concept, and there’s really not much to it. Now that you’re up to speed, you can start talking about ratcheting up your debt by an extra turn, just like a true private equity investor.