Should You Consider a Recap? Part 3

Should You Consider a Recap? Part 3

By Robert St. Germain

March 27, 2012

This series of blog posts examines the exit options of middle market business owners as they contemplate the sale or recapitalization of their companies.  My first two posts in the series described the seven primary ways owners leave their businesses – sales of assets, sale to partners, sale to children, management, employees, to the public and a third party… and the ramifications when the third party is a strategic buyer.  The third party financial buyer is another option that may be worth consideration.

A financial buyer, for this discussion, is a private equity group (PEG). This is a type of investment manager that raises funds specifically to be invested in the private equity of operating companies in accordance with a limited partnership agreement between it and its sources of those funds (e.g. pension plans, universities, insurance companies, foundations, endowments, and high net worth individuals). The funds typically have a ten year life, during the first half of which, capital is invested into companies and, during the second half of which, that capital and any appreciation thereon is harvested back out through the resale or IPO of those companies.

It is estimated that there are over 1800 PEGs in the U.S. with some $500 billion ready to be invested as of this writing. Each has its own investment criteria that define its targets of interest by industry, stage of company, EBITDA and/or revenue minimums/maximums, geographic location, purpose of investment, amount of investment, and minority/majority ownership requirements.

A recap in its most general sense could be considered any adjustment made to the liabilities/equity side of a company’s balance sheet. However, in the context of this discussion, it means the sale of a company to a PEG via a transaction that includes reinvesting or rolling over a portion of the seller’s proceeds from the sale to buy an interest in the PEG’s new entity, which holds the seller’s original operating company.

When considering a recap, sellers should pay particular attention to those PEGs with companies already in their portfolios operating in the same space as the seller. This is because, much like strategic buyers, they can afford to pay more in anticipation of synergies post-close and may even be competitive with what strategic buyers might offer.

An important feature of all PEGs is that they are necessarily focused on the management of their funds. Therefore, they rely upon the sellers of the companies they acquire to stay with and continue managing the enterprises post-close. Thus, continued employment of the sellers is standard practice in a recap.

Additionally, because the objective of a PEG is to generate a high a rate of return on its investment for itself and on behalf of its limited partners, sellers can expect to receive from them not only capital, but also helpful management expertise/experience, active board participation, coordination/integration with existing portfolio companies, and introductions to new suppliers and customers, as necessary, to rapidly improve operations and the company’s value in anticipation of the eventual resale or IPO.

Further, because the sellers typically stay on in an active operational role after receiving what could be “life-changing” amounts of money, the PEGs require them to reinvest some of those sale proceeds to retain some “skin in the game”. The percentage of ownership can be anywhere on the continuum of minority to majority depending upon the criteria of the particular PEG.


Middle Market Pulse


Posted by Robert St. Germain.