What is Business Recapitalization?
In an earlier article, “Taking Some Chips off the Table,” we followed Gustoff, the owner of
Precision Machine Company, as he sold a majority stake in his company.
As a follow up, I will
elaborate further on this strategy, focusing on two areas:
- The “Second Bite of the Apple” business recapitalization concept
- Using the sale of a majority stake as an estate planning tool
By selling 80% of Precision Machine Company, Gustoff re-capitalized the business using Other People’s Money (OPM) which enabled him to take the business to the next level, while retaining a 20% ownership stake for himself.
One benefit of his recapitalization was that he now had partners to work with him to grow the business.
Overall, Gustoff is in a great place.
He continues to work in a business and industry that he enjoys, he has more time for family and outside interests, and he has the potential to significantly increase the value of his remaining 20% interest. Plus, with this recapitalization, Gustoff is now positioned to take a “second bite of the apple” at some future date, typically in about five years.
Essentially, an owner hitches a ride as investors seeking above-market returns purchase a percentage interest in his business, enabling it to grow to the next level.
The owner is then set up to benefit from this increased value, in effect, taking a second bite from the same apple! Although there is no guarantee that Gustoff’s remaining 20% will increase in value, he has, at minimum, reduced his risk of future loss substantially by “taking some chips off the table!”
Gustoff had another reason to sell a majority of his business interest and “take some chips off the table”…
Gustoff needed to resolve an estate issue that he feared would affect the future relationships between his five adult children.
Of the five, only one child was involved in the business; the other four had no interest in anything other than the financial benefits. The one who was involved didn’t always see eye-to-eye with his father; building the value of the business was not in his best interest. Higher business value would mean higher cost for him in the future when he would be the logical one to buy out his siblings’ interest.
This is a common conflict in family-owned businesses as the interests of family members who are active in the business are at odds with those who are not active.
Non-active siblings, interested only in eventual financial gain, often oppose any additional financial investments in the business, even those necessary to sustain the business. The child working in the business feels constrained by his/her siblings’ interests, as well as at odds with the soon-to-be retired parent(s).
This is bad for business and bad for the family.
“Taking chips off the table” presented a solution for Gustoff:
- Converting a majority of his ownership interests to cash provided the opportunity to settle any future financial issues among his children now while he is still alive.
- He established trusts to hold the proceeds of the sale.
- The trust documents included policies and directions on investments that would insure that his concerns about long-term family security were addressed.
- Furthermore, Gustoff now had the ability to address the future needs of the active child without the conflict.
At the end of the day,
capitalizing on opportunity while you are alive and well could be the key to family harmony. “Taking some chips off the table” is one example of many successful family succession methods.