Cashing Out
Cashing Out Via Private Equity Recapitalization
“Should I keep it, or should I sell?” At some point in the business lifecycle, most owners grapple with that decision. Selling is a great way to gain liquidity, and let’s face it, cash in hand is an appealing prospect. But exiting the business you’ve worked hard to build is not an easy step. A private equity recapitalization is a middle ground that that gives owners liquidity without requiring them to sell the company.
What Is Private Equity Recapitalization?
In a private equity recapitalization, an investor or investor group buys out some, but not all, of the owner’s interest in a business. Some reasons owners might choose to get cash from the business this way include funding expansion of the business, diversifying investments in areas outside the business, or planning one’s estate and retirement. Recapitalization gives owners the opportunity to take cash out of the business while staying involved in the management and decision-making, if that is what they want to do.
Private equity investors usually but not always seek to buy at least 51% ownership in companies in which they invest. A few, but not many, are willing to buy less than a controlling interest. Private equity investors typically use “mezzanine debt securities” to finance the deal. Mezzanine debt—generally in the form of subordinated debt and preferred stock—is a hybrid between senior debt and equity. Like equity, mezzanine debt is long term and unsecured. Like senior debt, it has an interest component. The overall cost of mezzanine securities is usually higher than senior debt but lower than equity. Most mezzanine investments last from three to seven years. As the company grows, its earnings are used to pay off the mezzanine investment or to replace it with traditional debt.
Successful recapitalizations feature a good relationship between the business owner and the private equity investor—a relationship in which both parties are focused on the company’s continued growth. In fact, if the owner has an ongoing stake in the business it makes the investment more attractive to investors, because they don’t want to partner with somebody who doesn’t really care about the company’s future. By the same token, the business owner must be willing to accept the private equity investor as a partner in the business. Even after the mezzanine debt has been paid off, the private equity investor typically retains an equity stake in the company.
Expert Advice Is Key
Owners considering private equity recapitalization should get advice from a team of professionals, including experts in investment banking, law, tax, and business valuation. It’s important that all your financial decisions are based on an expert appraisal of your company’s worth. Owners often think they know their company’s value, but in reality they may be shockingly misinformed. For example, SPARDATA, a leading national business appraisal firm, surveyed 2,000 business owners in 2001 and found that most misjudged the value of their businesses by 50% or more—sometimes by millions of dollars.
