Exit and Growth Strategies for Middle Market Businesses

Think Recapitalization

By Roy Graham | Jul 08, 2008

Maybe you have read that the market has peaked and deals are tougher to get done. You feel like you have missed your perfect chance. On the other hand, you are not getting any younger, you still have most of your wealth tied up in your business, and you can not get the thought of possible capital gains tax increases out of your head. What should you do?

Think recapitalization. While not for everyone, a recapitalization or “recap” as often referred to, can provide an attractive option for sellers. A recap enables a seller to sell a portion of a business now, while keeping an ongoing equity stake, maintaining an active management role, sharing in the growth of the company, and retaining the opportunity to participate in better markets which may be ahead.

A partial sale now could yield considerable wealth with which to diversify into retirement appropriate investments. It could also avoid possible higher capital gains taxes that may apply to future sales. Once diversified, a seller may feel reinvigorated and more eager to expand a business with a partner’s help and co-investment. A recap is also appealing to most private equity groups because it demonstrates that the seller believes in the company’s future. It can mean the difference in doing a deal or not and can positively influence the amount of an offer.

The object of the recap is to grow the value of the company generally over a 3 to 5 year period at which time there is a subsequent sale. Often this growth is accomplished organically as well as through add-on acquisitions. While there are no guarantees, many private equity firms have successful track records of exiting their investments with lucrative returns for themselves and their recap partners.

It’s a smart idea to explore a recap with an experienced M&A advisor. A good M&A advisor knows the private equity firms that have successful track records with recaps and knows the critical areas that must be negotiated. Your advisor can show you how a surprisingly small reinvestment can enable a business owner to retain a significant stake in a company post transaction. He or she can also brief you on the importance and feasibility of pari passu treatment of reinvestments, abolishment of all personal guarantees and a host of other important aspects of a recap.

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