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Private Equity Recapitalization: How it Works

Owners of privately held businesses typically have a large portion of their personal net worth tied up in the companies they have worked hard to build. When considering liquidity and wealth diversification options, however, business owners often ask themselves an over-simplified question: “Should I sell or not sell?” The answer to this question does not have to be an absolute “yes” or “no” response.

Owners of privately held businesses typically have a large portion of their personal net worth tied up in the companies they have worked hard to build. When considering liquidity and wealth diversification options, however, business owners often ask themselves an over-simplified question: “Should I sell or not sell?” The answer to this question does not have to an absolute “yes” or “no” response. By considering a private equity recapitalization, a vast menu of sale and liquidity options become available depending on the business owner’s age, desire to remain involved with the business, vision for the business, and liquidity requirements. Simply put, a partial sale of the business to a private equity buyer (a recapitalization) can accomplish many of the business owner’s stated objectives without selling 100% – achieving some liquidity today, providing a path to additional liquidity on a future sale, and securing a deep-pocketed partner that is committed to growing the business.  Equity recapitalization transactions enable our clients to largely cash out of their investment in the business and capitalize on the enormous amount of sweat equity they have put into their business over the years.

An equity recapitalization represents an alternative to a complete sale of a company. The original owner can continue as a partner and/or manager of the company, while the new partner is a private equity firm that shares the business owner’s culture and vision for the future. Unlike some strategic acquirers who purchase with a view towards eliminating overhead redundancies, private equity firms prefer a more passive or board level involvement and a collaborative relationship with the existing owner and management. As partners, these private equity firms are able to bring strategic opportunities to the company that were not previously available, and can provide strategic management experience in order to assist the company to its next level of growth.

Today, in the United States, there are over 2,000 private equity groups with committed funds. These groups distinguish themselves in a variety of ways, but they all share the common goal of investing in and growing privately held companies. Most private equity groups have clearly defined characteristics they are seeking in businesses: size (revenue and/or EBITDA), industry, geography, and owner/shareholder objectives, among others. Matrix maintains close relationships with hundreds of these groups and has extensive experience in identifying the appropriate private equity buyers to include in an equity recapitalization process, depending on the business owner’s transaction goals.

v-1recap-chart-1

Consider the following example of an equity recapitalization to a private equity buyer:

graphic-Private-Equity-Recapitalization-02

Notes & Assumptions

  • The company is recapitalized at a valuation of 6.5x EBITDA.
  • Company debt of $4.0 million is retired by the selling shareholder, resulting in net proceeds of $28.5 million.
  • Any excess cash or other excess liquid assets would be retained by shareholders.
  • Current owners “roll-over” $5.0 million tax deferred and retain 36% of the equity – results in $23.5 million net cash to shareholders.
  • Sellers pay transaction expenses and taxes out of net cash proceeds.

graphic-Private-Equity-Recapitalization-02

Notes & Assumptions

  • A senior debt facility equivalent to 2.50x EBITDA is arranged.
  • Mezzanine debt of 1.25x is arranged.
  • Private equity group invests cash of $8.75 million for 64% of the equity.
  • Current owners “roll-over” $5.0 million tax deferred and retain 36% of the equity.

graphic-Private-Equity-Recapitalization-02

Notes & Assumptions

  • Management (previously non-owners) is provided with stock options for up to 10%.

 Net Result: Shareholders are able to extract 82% of the equity value of the company in cash while still retaining 36% ownership (versus 18%).

As this scenario illustrates, a business owner can elect to re-invest some proceeds from the sale back into the business (typically on a tax deferred basis) and maintain a significant ownership stake alongside a new private equity partner. While this outcome in very different than an outright sale to a strategic buyer, it allows a business owner to keep some “skin in the game” and realize significantly more upside when a future sale occurs (generally 3-5 years later).

The following table summarizes some of the primary differences a business owner can anticipate between an outright sale versus a private equity recapitalization.

                                            Recapitalization vs Complete Sale

v-2recap-chart-1

Private equity recapitalizations may not be the preferred transaction for every business owner, but they do offer a number of compelling considerations to be discussed prior to starting a formal sale process.

To summarize, private equity buyers provide the following deal characteristics for business owners:

  • Liquidity: Business owners can realize significant personal/family liquidity by selling part of the business and extracting 80% – 90% or more of their company’s current value, while retaining a disproportionate share of the remaining equity.
  • Diversification: Avoids the risks of having personal/family wealth tied to a single business enterprise – allows for prudent diversification of your wealth.
  • Upside: Entrepreneurs can participate in a “second bite of the apple” in 3 to 5 years by maintaining a meaningful ownership stake (30% or more) – by aggressively growing the business, you can create significant additional wealth.
  • Management Continuity: Owners and existing management maintain operational control of the business, and with new partners, focus on accelerated growth. An option program can broaden the equity participation to other tiers of management, who would otherwise never become owners.
  • Partnership: A well-capitalized partner with deep pockets and extensive business connections sets the stage for strong growth internally and/or through acquisitions.

If you have any questions or require any additional information regarding the information provided above, please feel free to contact:

David W. Shoulders
Managing Director
Matrix Capital Markets Group, Inc.
(804) 591-2034
dshoulders@matrixcmg.com

The contents of this publication are presented for informational purposes only. While Matrix Capital Markets Group, Inc. and MCMG Capital Advisors, Inc. (“Matrix”) believe the information presented in this publication is accurate, this publication is provided “AS IS” and without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranty of merchantability, fitness for a particular purpose, or non-infringement. Matrix assumes no responsibility for errors or omissions in this publication or other documents which may be contained in, referenced, or linked to this publication. Any recipient of this publication is expressly responsible to seek out its own professional advice with respect to the information contained herein.

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