For most business owners, a business sale is a once-in-a-lifetime chance that occurs shortly before retirement. It’s a perfectly reasonable approach that often comes with a large payout. Nevertheless, it might not be the most lucrative overall option. In fact, many businesses can fetch a higher price by selling the business in smaller parts through a private equity recapitalization.
Broadly defined, recapitalization involves restructuring a business’s equity and debt mix to optimize capital structure. The process might involve trading one form of financing for another, such as by replacing shares with bonds. Though it’s most often public companies seeking a higher stock price that use these strategies, private equity groups are increasingly using this approach with smaller and privately held businesses.
With a private equity recapitalization, the investor acquires a major stake in the company, with the owner retaining a minority stake. This causes a business to take on debt equivalent to the amount paid to the owner, protecting the new owner from spending their own cash or pulling too much cash from the entity. This alters the debt-to-equity mix of the business, offering the owner both the benefit of liquidity and of a minority stake in the company. Some owners even go through multiple recapitalizations to several different investors.
- In addition to offering an owner cash, private equity recapitalization can confer significant benefits. Those include:
A chance for improved strategic decision making. With multiple owners who bring diverse backgrounds to the company, a single individual no longer makes all decisions. Moreover, an investor’s industry connections can support faster growth.
- The risk of doing business—and the risk to a future potential buyer—is reduced. This is because the business no longer depends on a single owner.
- The business gains greater financial resources. This can finance growth through strategic acquisition and other investments.
- Management may have the chance to invest in the new entity. This gains management buy-in, aligning the interests of management and business.
- When the business is sold several years later, it will likely fetch a higher price.
Private equity recapitalizations, however, are not without risks. They don’t work for every business, or for businesses of every size. One of the biggest concerns involves overleveraging. PE firms also set specific requirements for recapitalization. This may stop them from investing in a business that is below a specific profitability threshold or revenue goal. In most cases, PE seeks companies with at least $2 million in normalized EBITDA or $20 million in revenues.
Owners must also consider timing issues and the investment horizon. PE firms normally seek businesses with the intention of growing the company, then divesting over about seven years. So owners need to weigh the investment horizon, then consider how this accords with their personal goals. An owner who hopes to retire soon may gain little from this strategy. Owners with a 5-15 year plan, by contrast, may find this approach far more profitable.
Recapitalizations can confer tremendous value—but only if the business is able to align with a PE firm’s expectations and goals. A well-run business is critical to bringing these goals to fruition, and many businesses need outside help to streamline their operations.
About Veber Partners
Veber Partners, LLC was founded in 1989 and has operated as one of the premier private investment banking firms serving the Pacific Northwest. The Veber team is comprised of seasoned investment professionals who all have past operational experience and broad industry exposure.
Veber Partners success is driven by its partners’ experience as both principals and as advisors, combined with their transaction skills gained over many decades and around the globe. Small enough to offer senior-level service to every client yet sophisticated enough to manage large, complex transactions, the firm utilizes the analytical tools of the finance industry while managing the emotional stress of any significant financial transaction.