The hidden math of leverage — and why some funds make money without changing anything, while returns explode when they make even minimal improvements
There is a very common type of transaction among small funds and investors who acquire relatively simple, stable businesses with strong EBITDA-to-cash conversion. These are deals where, even without improving absolutely anything, investors can double their money over a few years thanks purely to the effect of leverage.
To make this clear, I’ll start with a very simple example in which the investor buys a company and does not improve it at all, and then I’ll show what happens if the buyer is able to implement small improvements (nothing extraordinary).
Here’s the example.
A search fund acquires a company generating €2 million of EBITDA for €10 million (i.e., an EV multiple of 5x EBITDA).
The transaction is financed with €5 million of equity and €5 million of bank debt at 8% interest (entirely feasible for this type of deal).
Let’s assume the company generates €1.2 million of annual free cash flow (i.e., a 60% conversion of EBITDA to cash), which is used diligently to pay interest and amortize the €5 million of debt.
Year 1
▪️ Opening debt: €5.0M
▪️ Interest (8%): €400k
▪️ Cash available for repayment: €1.2M – €0.4M = €0.8M
▪️ Closing debt: €4.2M
Year 2
▪️ Opening debt: €4.2M
▪️ Interest: €336k
▪️ Amortization: €1.2M – €0.336M = €864k
▪️ Closing debt: €3.336M
Year 3
▪️ Opening debt: €3.336M
▪️ Interest: €267k
▪️ Amortization: €1.2M – €0.267M = €933k
▪️ Closing debt: €2.403M
Year 4
▪️ Opening debt: €2.403M
▪️ Interest: €192k
▪️ Amortization: €1.2M – €0.192M = €1.01M
▪️ Closing debt: €1.395M
Year 5
▪️ Opening debt: €1.395M
▪️ Interest: €111k
▪️ Amortization: €1.2M – €0.111M = €1.088M
▪️ Closing debt: €307k (essentially fully repaid)
The company is still generating €2M of EBITDA and is sold again at 5x EBITDA, i.e., for €10 million.
▪️ Remaining debt: €307k
▪️ Net value to investors: ≈ €9.7M
▪️ Initial equity investment: €5M
▪️ Total return: 93.9% (almost a 2x)
▪️ Approximate IRR: 14.3%
All of this with a buyer who is completely incapable of improving the business in any way.
Honestly, not a bad deal, is it?
Now let’s assume the buyer achieves a 5% annual operational improvement in EBITDA and manages to sell the company at 6x EBITDA at exit.
This scenario combines three very powerful effects:
▪️ organic growth
▪️ accelerated debt repayment thanks to higher cash generation
▪️ exit at a higher multiple
Year 0: €2.00M
Year 1: €2.10M
Year 2: €2.205M
Year 3: €2.315M
Year 4: €2.431M
Year 5: €2.552M
Cash conversion (60% of EBITDA):
Year 1: €1.26M
Year 2: €1.323M
Year 3: €1.389M
Year 4: €1.458M
Year 5: €1.531M
Year 1
▪️ Opening debt: €5.0M
▪️ Interest: €400k
▪️ Available cash: €1.26M – €0.4M = €0.86M
▪️ Closing debt: €4.14M
Year 2
▪️ Opening debt: €4.14M
▪️ Interest: €331k
▪️ Available cash: €992k
▪️ Closing debt: €3.148M
Year 3
▪️ Opening debt: €3.148M
▪️ Interest: €252k
▪️ Available cash: €1.137M
▪️ Closing debt: €2.011M
Year 4
▪️ Opening debt: €2.011M
▪️ Interest: €161k
▪️ Available cash: €1.297M
▪️ Closing debt: €714k
Year 5
▪️ Opening debt: €714k
▪️ Interest: €57k
▪️ Available cash: €1.474M
▪️ Closing debt: €0
▪️ Excess cash: ≈ €1.5M
▪️ EBITDA (Year 5): €2.552M
▪️ Exit multiple: 6x
▪️ Enterprise value: ≈ €15.3M
▪️ Outstanding debt: €0
▪️ Additional cash generated: ≈ €1.5M (can be distributed as dividends or added to exit proceeds)
Total value to investors: ≈ €16.8M
Initial equity investment: €5M
The return is massive compared to the no-growth scenario.
The investment grows 3.36x in five years
The resulting approximate IRR is 27.5% per year.
An extraordinarily high return for a business growing EBITDA at just 5% annually, where the magic comes from combining operational improvement, accelerated deleveraging, and multiple expansion at exit.
▪️ A simple, easy-to-operate business that the new team can fully understand from day one.
▪️ A diversified customer base with limited dependence on personal relationships.
▪️ Low churn and stable customer relationships.
▪️ Strong EBITDA-to-cash conversion, avoiding businesses with high CapEx or working-capital intensity.
▪️ Businesses with no operating history, as behavior is difficult to predict.
▪️ Extremely fast growth, which is usually expensive and full of uncertainty.
▪️ Stagnant or declining revenues or margins, which add complexity and risk.
What they want is predictability.
Neither hypergrowth nor decline, nor unproven business models.
A company whose past allows its future to be anticipated with minimal surprises.
These deals work very well when everything remains stable, but they can also fail for fairly simple reasons. Poor management, mistakes during the transition, or bad decisions by the new team can quickly deteriorate a business that previously functioned well. A recession, abrupt sector changes, or the entry of an aggressive competitor can stall or reduce revenues.
With leverage, any setback is magnified because debt must be serviced every month and interest does not forgive. A business that stops generating the expected cash can enter distress very quickly.
Even if the business remains stable, selling it may prove difficult. If the company has not scaled meaningfully, many investors will prefer acquiring a family-owned business with runway ahead rather than a professionalized one with no clear progress.
In that case, the only real exit may be a strategic buyer—and that only works in sectors where consolidation is actually taking place. If it isn’t, exiting the business can be challenging.
The upside is that if the company is stable and generates cash, even if an exit proves difficult, it can always become a cash cow, distributing dividends and eventually returning the investment over time. It may not be the financial investor’s original plan, but it can still be a respectable outcome for a deal that didn’t turn out exactly as expected.
By Joshua Novick, partner at Bondo Advisors
Source: https://www.joshuanovick.com/p/como-duplicar-tu-dinero-comprando
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