Recapitalization and Business Owner Flexibility
Many business owners find themselves approaching retirement age but their wealth is tied up in their largest and most important asset, their business.
If this scenario sounds familiar to you, recapitalization is a great option.
A recap is essentially an alteration of the company’s financial structure by adding debt, bringing on investors, or buying out old investors without issuing new stock. It’s an increasingly popular method for businesses to give liquidity to owners without selling the entire business or diluting share distribution.
Recaps can address many scenarios that entrepreneurs commonly face:
– When a company has multiple owners and one or more need to be bought out for either retirement or differing professional goals
– The burdens of an untimely death when cash is needed to cover estate taxes
– Succession transactions
– Growth investments
Depending on your situation, the type of recap that would be most beneficial can vary, so here is a quick overview.
Perhaps you still love the daily grind of business ownership and couldn’t imagine retiring, but you still need to diversify by turning your equity into cash. In this case, a minority recap is the best choice.
With this option, you retain majority ownership and operational control of your business and bring on an investor, usually a private equity firm. The investor will use a combination of debt and equity to infuse your business with cash. As with all recaps, the cash can be distributed as necessary to shareholders. However, in this case, it is often used as a tool for growth.
A minority recap provides the tax advantages associated with debt, the flexibility of liquidity, and the benefits of strategic help from experienced finance and business experts. All of these benefits can be used to make new investments while retaining complete control and majority ownership of the company with the option to regain 100 percent equity ownership down the road.
If you’re looking for an exit strategy, but still think that the business you’ve created has high growth potential, then a complete sale may not be the best option. In this case, a majority recap is a better choice.
A majority recap means that an investor, usually a private equity firm, acquires at least 51 percent equity in your business while you retain minority ownership. This allows you to decrease your day-to-day responsibilities while providing the most amount of liquidity outside of an outright sale. Generally, a higher valuation is achievable compared with other recap options because the investor gains operational control.
This option is most popular for business owners who want to retire but think it would be financially beneficial to retain a share of ownership for future liquidity events.
Dividend or Debt Recap
For business owners who are not interested in taking on an investor and don’t want to decrease their proportion of ownership, but still need liquidity then a majority recap, minority recap, or complete sale are not good options. Instead, you should consider a debt recap.
A debt recap is essentially a loan issued by a bank usually based on assets or a loan issued by a specialty lender usually based on a multiple of EBITDA. They are very common for family succession transactions.
This type of recap allows for owners to retain 100 percent ownership and operational control. They are a relatively fast and confidential type of transaction because there are few parties involved. The liquidity can also be used for growth strategies and the debt is often helpful for tax purposes.
However, there are notable downsides to debt recaps compared to other recap options. First, they are difficult to qualify for and banks will often require personal guarantees so that they have secondary security for the debt. Second, the owner will have to be able to offset the expense of the debt stressing cash flow. Third, there will be increased reporting requirements to debt providers.
As with all complex transactions, it is essential for business owners to be prudent by hiring proper representation to facilitate recapitalizations for three primary reasons:
1. Partnering with experts who are adept at ensuring proper valuation helps owners gain maximum liquidity.
2. Having an expert who can run the recapitalization process on behalf of the owner reduces the owner’s distraction from business operations.
3. M&A transaction experts can help owners navigate common pitfalls and ensure all legal and tax factors are accounted for.
The experts here at Symmetrical have been helping middle market business owners reap the benefits of recapitalizations for decades. If you are in need of liquidity from your business and think that a recapitalization could benefit you, then contact us today.