Generally, Cephas is seeking investment opportunities where most of the following criteria are met:
- Business is operated by a skilled and motivated management team that controls a majority of the equity capital and seeks to grow the business over time.
- Companies meet SBA’s definition of a “small business”, which are those with a tangible net worth of less than $19.5 million and an average net income for the last two years of less than $6.5 million.
- Company has a capital need of not more than $5 million, and preferably an amount in the Cephas target range of $500,000 to $4,000,000. Needs greater than the Cephas cap may be met through efforts by Cephas to find a participant in the financing.
- Enterprise is generating positive cash flow at the rate of at least $500,000 annually with capacity for this cash flow to be further leveraged insuring positive fixed charge coverage on a pro-forma basis.
- We expect companies to have established positive relationships with senior lenders and any other funding sources to insure that full financial support is in place to execute the growth plan.
- While we will consider businesses operating in almost all industries other than real estate, finance, and natural resource type situations, we prefer areas where a measurable competitive advantage can be demonstrated and maintained in the future.
A majority of the financing transactions completed by Cephas to date have involved the change in ownership of established profitable businesses. As the “baby boom” generation continues to exit from their business interests, we believe the Cephas option will continue to be a popular alternative for solid businesses to be successfully transitioned to new locally controlled management, preserving jobs and supporting the communities we live in. These deals typically come together using the following general blueprint:
For the purpose of this discussion, we’ll assume “Upstate Business” generates $1 million of annual EBITDA, and is being sold to “Local Operating Management” for $5 million, or 5x cash flow (“cf”).
We would expect the funding for such a transaction to come together as follows:
- Senior Creditor provides a $3 million 7-year term loan (3x cf) along with a working capital line of credit. Full amortization of the debt begins immediately after closing.
- Cephas provides a $1 million 7-year term loan (1x cf) in a secured subordinate position to the senior creditor. Cephas structures its’ repayment around projected cash flow but typically provides a 1-3 year interest-only period. Given the additional risk being taken, Cephas would negotiate some sort of equity feature to participate in the expected enterprise value growth over the life of it’s investment.
- New owners “Local Operating Management” contribute at least $500M (10%) cash equity plus cover all transaction costs.
- Seller takes back a junior subordinate note for the remaining $500M in a position junior to both the Bank and Cephas. In some cases, this portion of the financing need can be met through various economic development financing options available in the market.
- First year cash flow coverage, so long as “Upstate Business” continues to generate $1 million of EBITDA, would reach a comfortably positive 1.3:1 level.
- It’s expected that “Local Operating Management” would implement growth initiatives driving EBITDA to higher levels over time. As cash flow elevates, a further cushion is created to begin amortizing the Cephas principal.
- As cash flow increases, senior debt is repaid, and “Local Operating Management” demonstrates a positive track record, the Company positions itself to refinance the Cephas debt with the Senior Lender.