At some point, most founders and owners face financial constraints and consider whether they should sell their business. What most of them don’t know is that there is an option to sell the business and still have the opportunity to participate in its future growth. Recapitalization allows owners to sell part of their shares and cash-out while staying involved in the day-to-day. This allows then to take a ‘second bite at the apple” when the business is sold in the future. As such, this is an important tool that provides business owners with growth and liquidity options.
Recaps are typically used to provide founders and owners with partial liquidity while retaining some ownership and control. It allows current shareholders seeking a liquidity event to take some chips off the table, thus reducing their risk and exposure in the company by selling shares. This may be an interesting alternative for entrepreneurs and equity owners seeking a capital infusion while keeping the chances for an upside. What is particular about a recap is that, different from a traditional M&A transaction where ownership fully changes, a recap allows owners and company shareholders to sell partial equity while retaining some level of ownership and control of the company.
Recaps may be an attractive opportunity for business owners who may need capital for new equipment and machinery, inventory, new product lines, marketing, hire key talent, expand into new markets and diversification. It can also be used to buyout a non-active partner, improve the balance sheet or for personal/estate planning purposes. In most cases, these transactions include some portion of the owner’s equity in the company.
Recaps unlock the value that is tied up in the owner’s equity and create a liquidity opportunity. The owner also maintains the option of retaining an equity position and remaining involved. This may be interesting if he/she believes the company has the potential to grow and exit altogether in 3-5 years. This could have a substantial second liquidity event for the owners and shareholders. Alternatively, owners may have the option of exiting altogether.
Recaps are most popular among private equity groups and investors who invest in privately held companies. These are usually under performing and in need of fresh capital. Generally they purchase more than 51% to secure control and seek to partner with existing management. The owner is able to take some chips off the table while retaining some ownership and decision-making power. Private equity groups provide capital, managerial expertise and relationships that hopefully can help the portfolio company become profitable and grow. The ultimate goal of the private equity groups is to improve the business financially and operationally in 3 to 5 year period and eventually make an exit at a significant gain.
Private equity groups make both control and minority investments in mature, growth-oriented companies seeking capital for future expansion. Companies must demonstrate a history of consistent revenue growth and profitability with solid cash flow.