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Private Equity Recapitalization Offers Business Owners Options Besides “Sell” And “Keep”

After putting your blood, sweat and probably tears into building your business, you undoubtedly have a considerable part of your net worth that is tied up in the business. At some point, however, all business owners ponder concerns about the effort involved to promote further growth weighed against thoughts of selling the company and retiring. Deciding whether to keep the business or sell it may seem like a binary decision. However, private equity recapitalization is another option that can present the best of both options for you and your family.

A private equity recapitalization offers an alternative to a complete sale of the company for a business owner who wants to remain involved with the business. Much like a home equity loan gives the residence owner capital, while transferring part ownership of the home to the bank. A private equity recapitalization of a business takes advantage of sweat equity and brings in fresh funding and business partners to foster growth. Instead of loan payments, their investment is recouped in profits and future sale proceeds.

How equity recapitalizations work

Selling part of the business to a buyer (a private equity recapitalization) brings in additional funds to enhance operations or reduce debt. This allows the original owner to continue as a partner or even the firm’s manager, while the new partner supports the business owner’s vision for the future. Partnering with an equity firm can provide needed liquidity now for growing the business while retaining the option of a future partial sale to raise additional funds or a selling 100 percent of the venture.

For family businesses, a recapitalization does mean giving up a piece of the family’s assets and some control. Deals vary; however, most equity deals seek at controlling interest (at least 51 percent) in a firm. Nevertheless, private equity investors/firms typically prefer a more passive involvement going forward. They allow current management to retain operational control and strive to build a collaborative relationship with the existing owner and personnel.

Private equity and wealth management firms, such as HJR Global, have different time horizons (can range from 5 to 7 years up to 10 to 12 years) in which they expect to return the investment value and profits to investors. Accordingly, they will work with the original owner to grow the business and reduce any debt during that time. As partners, they may suggest strategic opportunities or way to increase company value that you had not considered before. After all, their goal is to enhance the value for any future recapitalization or outright sale.

The investor perspective

The performance spread in private equity investments is wider than in other asset classes because recapitalizations can increase a company’s value as well as lead to secondary sales and, in some instances, an initial public offering. They typically involve groups of accredited investors working with a firm such as HJR Global who have a strong incentive to enable your firm to run smoothly and grow quickly. Private equity funds or deals have generated a higher return than the stock market in the past two decades. As a result, more people today are looking to invest in them.

Who should consider the option

Private equity recapitalizations are an ideal option if you are:

• A business owner who wants to stay involved in the firm you built.
• Seeking to raise money to fuel expansion of your business and increase its value for a complete sale in the future.
• Worried about succession-planning solutions and intergenerational transfer of wealth.

From a financial perspective, the best candidates for an equity recapitalization have:

• Consistent earnings with predictable recurring revenue.
• Low capital expenditure requirements.
• Minimal bank debt.
• Solid prospects for growth.
• Earnings before interest, taxes, depreciation and amortization (EBITDA) margins over 10 percent.

However, specifics vary by industry and situation. Some private equity managers specialize in particular market sectors to develop and provide more extensive investment experience.

What the risks are

There are risks involved in any financial deal and business strategy. However, taking on a private equity recapitalization is essentially like taking on a partner. So it is important to make sure that you are on the same page about your vision for the firm and theirs. Areas that present risks and potential issues that should be addressed before signing a deal can be:

Control.Many business owners fear that selling to a private equity fund or firm will mean a loss of control. In a recapitalization involving only part of the business, operational control often remains with the original owner. The investors act as board-level advisors and focus on ways to accelerate growth. Other deals may include more active roles in guiding growth.

Investment time horizon. Equity funds and partners have lifecycle expectations from initial investment through value creation and when investments should be harvested with a future sale. There should be an agreement on a realistic time period before making a deal.

Personnel. There should be an agreement as to who has a say on any changes to existing management. After all, they are investing in your expertise and your team as well as your firm.

Deep pockets. A well-capitalized partner has the capacity and willingness to invest additional funds in the business if unexpected opportunities or issues arise. It is wise to make sure the investor has deep-enough pockets to invest additional capital, if warranted.

Debt and valuation. After the recapitalization, your company will carry a significant amount of debt on the books as part of the deal. This may make you uncomfortable. Additionally, there is no guarantee that the value of your firm will grow as expected and present a more lucrative sale opportunity down the road. That said, the equity partner will strive to help ensure that the valuation they expect is realized.

Where to get advice from

Any business owner has grappled with ideas about selling the business, succession planning and boosting capital to finance growth. With so many business-owning baby boomers retiring in the next decade, private equity recapitalization is attracting more interest. However, you want to make sure that you work with a wealth management firm that is committed to more than making a deal. You want a partner committed to helping businesses grow by providing resources that are needed, financially and strategically.

HJR Global works with firms in all phases of development, from startups to those planning growth. They also help businesses with financing, including venture capital and private equity recapitalizations. If the right funding is what you seek, you have come to the right place. To learn more about how HJR Global can help finance your small business needs, please contact us.

To read more from HJR Global, check out our latest post here.