The Benefits Of Recapitalization
by Bill Trudeau
As we emerge from this latest downturn,
many owners of private companies are concluding that this is the
last such slump they want to experience. Some are not yet ready to
retire, so what are their options?
One solution is recapitalizing the
company. This method is back in vogue as the private equity and
senior lending markets rebound.
A recapitalization is a transaction in
which a company reallocates the equity and debt on its balance
sheet. Existing shareholders exchange some or all of their equity
for cash, while still maintaining an ownership interest in the
company. Exhibit #1 outlines the mechanics of a recapitalization.
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The Mechanics
Of A Recapitalization |
|
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An Agreement is reached to sell 70 percent of
the equity in Company X to a
sponsor and allow management to reinvest some of it's equity
on a tax free basis.
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Company X can support senior debt of $50mm. The
shareholders
receive $85 million in cash and reinvest $15 million to
keep a tax-free 30 percent ownership position in Company X.
Exhibit 1
Source: Trudeau &
Trudeau Associates
|
This transaction not only has the potential to position the company
for future growth, but it also offers numerous advantages to the
owners, the management team and the new equity providers.
The Owner
The owner has been deeply involved in the daily operations of the
company for many years. In addition, the owner's personal wealth is
usually locked in the equity of the company, while the risk of
liabilities such as personal guarantees of debt may also exist.
Recapitalizations offer the owner many advantages. Recaps unlock
the value of the owner's equity by creating substantial liquidity of
their personal net worth, which promotes effective estate planning.
An owner also maintains the option of retaining an equity position
and remaining involved in the company's operations, or of exiting
the company completely and moving to the next phase of his or her
life. Finally, the owner choosing to stay with the recapitalized
company will have the opportunity to receive a "second bite of the
apple" when the company is sold by the sponsor in the future via an
IPO or the sale of the company to a strategic acquirer.
The Management Team
The management team comprises those individuals who are usually not
shareholders at the time of the recapitalization but are most
knowledgeable about the company's operations. A recapitalization
will provide the management team with the opportunity to become
equity shareholders as the equity sponsor creates stock option
incentive plans to motivate the management team.
The Bank
The bank is the lender of senior debt and will provide a line of
credit collateralized by the company's accounts receivable,
inventory and other assets. Recaps provide the bank with a vehicle
to lend money to a stable, growing and well-managed company in which
the management team, sponsor group and the bank all can share in the
reward of success as well as the risk of failure.
The Private Equity Sponsor
The equity provider, commonly called a sponsor, loves recaps. The
sponsor invests in a company with a solid management team that will
inherently grow the company internally or through acquisition,
allowing a profitable exit from the investment in five to seven
years with an IPO or sale to a strategic buyer. A recap is a
perfect vehicle for the sponsor to invest in a company with the
management team having a significant stake in the success of the
firm.
The M&A Firm
The merger-and-acquisition specialist is like the conductor of a
symphony. It brings all the pieces and parties together and
orchestrates the transaction. The M&A firm evaluates the company to
determine the feasibility of the recap, advises the principals and
typically assists in the negotiation process.
A recapitalization is a viable way for company owners to gain
liquidity, position a business for growth and reward management with
equity moving forward.
If the thought of slugging out another business cycle as an owner of
a privately held company has you nauseous, consider a
recapitalization as a way to pick the fruit of your labor, because
recaps are back in bloom.
This article was written by William R. Trudeau, founder and
president of merger-and-acquisition firm
Trudeau &
Trudeau Associates Inc. and appeared in Boston Business
Journal.
Click here to view the Boston Business Journal Publication
and the Bank of America Capital Eyes 2
