What if you could cash in on your business, diversify financial risk, and still keep your job? In other words, have your cake and eat it too. I know what you’re thinking—too good to be true. Actually, it’s more than true; it’s one of the most popular forms of ‘external’ business transfers. The private equity group ‘recapitalization’ or ‘recap’ provides the best of all worlds to the business owner looking to cash in and stay involved.
Why Choose a Recapitalization?
The simple answer is – Perhaps you’re not yet ready to walk away completely. Even if you’re not sure, this ‘partial’ exit strategy is worth exploring. This newsletter provides an introduction and then, you decide whether this strategy fits your Goals.
On a basic level, a recapitalization of a privately held business refers to the sale of a controlling stake in the entity—most likely to a private equity group. ‘Private equity groups’ collect capital from investors and provide an otherwise unavailable opportunity to invest in privately held businesses (they also take publicly traded companies private). Attracted to the high private equity returns of recent years, investors have increasingly steered investment dollars toward these groups, making ‘recapitalization’ a much more viable option for business owners looking to achieve a ‘partial exit’.
Still with me? Let’s get more specific. A private equity group invests in a controlling (51% to 100%) stake in a private business, while the business owner usually keeps anywhere from 1% to 49% ownership and continues to manage the business. The structure serves several purposes. First, an employment contract allows the equity group to take advantage of the owner’s business expertise within the day-to-day operation. Second, share ownership, even at a minority level, properly aligns the interest of both business owner and equity group investor toward growing the business. This owner now stands to benefit from a second liquidity event years later, referred to as a ‘second bite of the apple’, when the private equity group sells the entire company.
Assuming the private equity group has invested new capital and management resources in the business (beyond what the owner could bear as a ‘personal cost’), the ‘second bite’ can be worth more money then the original ‘recap’ value. In this transaction, everyone wins, as the private equity investor takes on risk to gain a large piece of the upside while the business owner diversifies risk and keeps a hand in the business – both professionally and financially.
What’s the Rub?
Don’t all rewards in business and life come with risk? In this instance, the biggest risk is loss of control along with that sale of a majority stake. All discretionary decisions, from strategy to financial, must pass muster with the majority owner. For instance, an owner might see an opportunity and want to simply take it. But now he must answer to someone, even if he feels he knows what’s best for the company. If differences of opinion regularly arise, he may resent the veto power of the equity group, which can in turn hinder business growth. The key to success with this type of transaction is making a good ‘cultural’ match between private equity group and business owner. Owner (and advisor) will want to look for an equity group that shares his vision for the company’s future and is willing to finance it and provide professional management.
Best of All Worlds for the ‘Torn’ Owner
Many business owners are not ready to quit cold turkey. It’s a daunting prospect; after all, the business has become your life over the last many years. Take a look at your personal Goals. Some of them might appear conflicting. If you’re torn between your business and the unknown of retirement, consider exploring this ‘partial’ exit strategy in more depth. A ‘recap’ can reward the right owner with a way to cash in some chips, diversify risk, keep a hand in the business and participate in future upside.