Recapitialization: the Basics
Have you ever heard the term “taking chips off the table” in relationship to the ownership of your business?
Just like in poker, you began by purchasing a certain number of chips. If you are fortunate, have played your cards right, and haven’t bet the farm on too many hands, you have probably built your initial investment into a sizable sum.
At this point in the game, some folks like to leave all the money on the table to show their staying power in the game and to support their bluffs and strategies.
Others want to “cash in” and bank their winnings.
As a compromise, some may convert a portion of their chips to cash and place the proceeds in a secure place. This conservative approach enables the player to continue to play while securing a substantial portion of their winnings.
Business owners can use this same strategy as a way to “have their cake and eat it too” when considering selling the business
Often buyers want to purchase a business and capitalize on the expertise of the previous owners by keeping them involved as well. This approach ensures continuity for the buyer and reduces their future ownership risk.
It’s good business practice and is an arrangement that is preferred by many private investors and Private Equity Groups who expand and tailor their portfolios through the targeted purchase of businesses. Typically, these folks don’t want to run the businesses they buy; instead they want to participate in the earnings of the business and acquire like-kind businesses to create greater scale with the ultimate goal of increasing earnings.
The financial benefit to the seller is the access to capital this arrangement provides.
Let’s face it; the economy is still suffering from the crisis of 2008. We still have a way to go before banks will be in a position to accept much risk. Prior to the financial crisis, it was fairly easy for buyers to secure a loan from a lender in order to purchase a business. Today, it is much more difficult for traditional buyers to find financing to support their purchases. This, in turn, makes it difficult for sellers to sell.
As we wait for lending to resume, one option is for owners to sell a portion of their interest in their business for cash today, while retaining a smaller (perhaps less than controlling) interest in the business.
The term often used to describe this action is “Recapitalization.”
Recapitalization can be a very useful exit strategy for owners who want to sell the business, but are not yet ready to get out of the game entirely.
It can also work for owners who are ready to sell, but cannot find a buyer able to purchase their entire business in the current economy.
Here’s an example of a common “Recapitalization”
Gustoff, the owner of Precision Machine Company, would like to relieve some of his stress, spend more time with his family and grandchildren, and travel a bit more. He hasn’t developed many hobbies since his business has pretty much been his life, and he still feels very connected to his industry. Basically, he likes what he does.
Gustoff is approached by a well-capitalized Private Equity Group that would like to purchase his business. They have other machine companies already within their portfolio and would like to purchase even more.
They recognize Gustoff’s expertise, his leadership in the industry, and his value to the company. The Private Equity Group offers to purchase 80% of Gustoff’s business for $8 million dollars, leaving Gustoff with 20% of the business for future appreciation.
Gustoff ends up with $8 million in the bank, more time with his family, and he still has a hand in the game! Not a bad play!