Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
Recaps have flourished as owners look to exit businesses they’ve built and monetize the value created by years of hard work.
Despite growing popularity, recaps are sometimes perceived as complicated processes, too difficult for the average owner to consider.
These perceptions are misconceived. Here’s why.
A recapitalization involves exchanging the owner’s equity for a combination of cash and a piece of the capital stock of a new entity (“NewCo”) designed to support the company’s continued existence and future growth.
Recapping is the equivalent of taking some chips off the table, but the owners stay in the game.
Typically, a private equity firm purchases a majority of the business, with the owner retaining a stake in NewCo. The former business owner (“OldCo”) benefits from NewCo’s future growth in value and realizes an opportunity to get a “second bite of the apple” at some point in the future.
Recapitalization has proven to be an effective answer to many concerns about business succession and exits, such as the following.
Business has outgrown owner’s expertise. A qualified financial partner brings new strengths to the business, such as growth capital, management resources and experience in building and operating companies. It can also provide a new sounding board, a fresh perspective on the business, and specialized industry expertise.
Lack of a successor. Family-owned businesses may have no logical successor to lead the company. Recapitalization enables an internal or outside management team to buy in, ensuring continuity of the business.
Established owners look to minimize personal risk. Recapitalization allows the company to be aggressive in executing growth strategies without personal financial exposure.
Family members desire liquidity. Recapitalizing OldCo provides instant liquidity for all shareholders. Family members may continue to be involved with NewCo, either in management or financially.
Management needs room, and support, to grow the company. Private equity firms give management significant autonomy to make decisions and move the company forward, while providing the underlying financial strength to accomplish those goals.
1. What is the investor’s experience in your industry?
2. What is its reputation among other management teams for integrity and delivering on its promises?
3. What value can your prospective partner add to your operations?
4. Will it allow you to operate independently if you decide to remain with your company?
5. Will it provide capital to support growth?
6. Can it close a transaction in a timely fashion?
1. Defined growth plan; do you know where the company is going and how to get there?
2. Consistent earnings, spanning several years of operation.
3. Significant market share or a strong niche position.
4. Experienced management team, committed to remaining with the business.
Here’s a hypothetical example of how a recap for a small to mid-sized family-owned company might work:
The company: The long-established family-owned Acme Co. has revenue of $10 million and EBITDA (earnings before interest, taxes, depreciation and amortization) of $2 million. Acme has a proprietary niche in manufacturing with a diverse customer base.
The founder/owner owns 90 percent of the stock, while a daughter holds 10 percent. The company is valued at $10 million, 100 percent of the stock, or 1 times revenue and 5 times EBITDA.
The scenario: The father wants to step back from operations and let the daughter take over management.
The recapitalization: A private equity firm recapitalizes the business, setting a new, stronger course for its future.
A new capital structure is established for NewCo, consisting of $3 million cash from the new equity investor, $3 million senior debt, $2 million mezzanine debt, $1.5 million subordinated note to shareholders of Acme, and $1 million equity in NewCo in lieu of cash for father and daughter. Total capitalization of NewCo equals $10.5 million, including investors’ financing costs.
At closing, the father receives pre-tax cash of $6.75 million, 23.33 percent ownership of NewCo and a 90 percent share of Acme’s subordinated note. The daughter receives pre-tax cash of $750,000, 10 percent ownership of NewCo, and a 10 percent share of Acme’s subordinated note. The private equity firm owns 66.67 percent of NewCo.
The scenario above shows how recaps can provide benefits to owners. First, partial liquidity enables the owner to diversify his net worth and secure his estate.
Second, the father and daughter will eventually be able to gain financially a second time when NewCo is eventually sold or merged.
Third, the father can step back from operations while contributing to NewCo’s growth in an advisory role. The daughter has a continuing role and ownership in NewCo. Both may be rewarded through management incentive plans and increased equity options.
In short, recaps can offer to owners financial security, new freedom for the business to grow and take risks, and new partners with fresh resources and perspectives. They can go a long way to helping family-business owners face today’s business challenges.
