Many business owners view the sale of a business as a one-time event taking place shortly before retirement. This very rational approach may not be the most advantageous transaction structure available. The most lucrative sales typically come from selling your business multiple times under a private equity recapitalization structure.
Recapitalization is broadly defined as the restructuring of a company’s debt and equity mixture in order to optimize its capital structure.
Under the private equity recapitalization model, the private equity investor acquires a majority stake in the business and the owner retains a minority stake. Usually, this results in the business borrowing money to pay the owner. As a result, the company’s debt-to-equity mix is altered and the owner realizes some of the inherent value of the business now while retaining the right to future value from distributions or the business’s eventual sale several years later. Some owners may even go through multiple sales from one investor to another while being incentivized to stay on with the business through an equity stake.
In addition to the owner cashing out for a portion of the business’s value, other benefits arise from private equity recapitalizations. We believe the following five key benefits are important since they impact the owner, investor, and management team:
- Multiple owners with different backgrounds create greater opportunity for strategic decision making and the investor will likely have connections that facilitate rapid growth.
- Business risk is diminished since the business is no longer reliant on a single owner.
- Management is normally granted the opportunity to invest in the new entity, which aligns its long-term interests with that of the business.
- Greater financial resources to support strategic acquisition and growth strategies.
- Capital gains from the sale of the business several years later – presumably at a much larger valuation.
Private equity recapitalizations have certain risks, the greatest of which is overleveraging. Such risk is mitigated with sufficient and consistent cash flow. Timing and investment horizons, are not necessarily a risk, but should be considered. Private equity firms typically acquire a business with the intent of growing and divesting the business over a roughly seven-year window so an owner needs to consider how well the investment horizon aligns with their personal timeline.
