Archive for April, 2009

Leveraged Recapitalization

Tuesday, April 21st, 2009

In a leveraged recapitalization a the company being sold takes a loan for the majority of the purchase price, the new owners put in some equity capital, and the existing owners retain an equity stake.  For example, a company valued at $10,000,000 might be recapitalized as follows:

Existing owners equity capital: 1,000,000

New owners’ equity capital:       1,500,000

Bank Loan:                                7,500,000

Total Capital:                           10,000,000

The existing owners retain 40% of the equity in the company but pocket 9,000,000 in cash (less transaction costs and taxes of course).  The owners then grow the business and exit by selling (usually in 3 to 5 years).

There are of course issues with this deal structure, such as the ability of the business to repay the loan from cash flow, maintaining adequate capital to grow the business, how well existing owners and new owners can work together, the skills that each party brings to the table, and how major decisions are made.  An owner who wants to take money off the table, however, can take a lot of money out of the business while maintaining significant upside potential and gaining a new partner that brings skill and capital to the table.

Selling Part of Closely Held Company

Sunday, April 12th, 2009

I just returned from a meeting where a company owner discussed selling 60% of his company to a Private Equity Group.  At first glance this seems like a bad strategy.  The owner gives up control, and 60% of the profits.  It is difficult to protect your interests as a minority partner in a closely held business.  The new owners can force changes in strategy, operations, etc. and yet the existing owner is still tied to the business.  So, why would any owner take an offer in which another entity acquires a controlling interest in a business?

There are a variety of advantages to the existing owner in this deal structure.  First, the Private Equity Group that is acquiring the controlling interest is interested in growing the business and exiting in three to five years.  They have a track record of successfully growing businesses by bringing additional financing and expertise.  If the existing owner retains 40% and sells in three years he can share in that growth.  The owner interests will be protected both by the purchase and sale agreement and by the fact that the PEG wants the owner to be motivated and grow the business.

This deal offers the owner, who has the majority of his net worth tied up in the business, the ability to take some chips off of the table and diversify to reduce his risks.  It does so, in a way that allows the money that comes out to be treated largely as a capital gain for tax purposes.  So, the potential upside may outweigh the dangers of being a minority shareholder in a closely held corporation