Selling Isn't an Owner's Only Liquidity Option

An outright sale isn’t the only option for business owners who seek liquidity. If you need to raise cash yet still want some control over your business or hope to transfer it to your managers or family members, a leveraged recapitalization may be an option. Depending on the form of leveraged recap, you could remain at the helm or enable your successors to assume ownership.

Not Ready to Give Up Control?

Leveraged recaps take one of two forms. The first is when an owner partners with a private equity (PE) group to share ownership. This method typically is preferred by owners who aren’t yet ready to give up control of their company. 

When you partner with a PE group, it buys a portion of your equity — usually between 60% and 80%, but possibly as much as 100%. The PE group usually includes debt as part of the finance structure to reduce its out-of-pocket cost and to secure a portion of its principal investment in the event your company fails. PE investors finance their acquisitions with a combination of funds from their general investment pool and senior and subordinated bank debt. They usually intend to sell their investments within five to seven years.

A PE group will have input into your company’s major strategic decisions and may attempt to realize synergies with your company and others in its investment portfolio through, for example, shared sales and marketing resources. But it’s likely to be hands-off when it comes to day-to-day operations. In many cases, private equity groups depend on the experience and expertise of a company’s existing management team. Your team will be expected to have some kind of equity investment in the business and may receive further performance incentives in the form of equity options.

Because private equity groups eventually sell their ownership interests — generally to another private equity group or a strategic buyer, but possibly as an initial public offering — this structure may not be the best option if you want to keep your business in the family. Also, the most likely candidates for private equity investment are higher-growth companies.

Wary of Outsiders?

Leveraged recaps can also take the form of management buyouts. In this scenario, a company’s managers borrow money to redeem the principal owner’s shares or pay an extraordinary dividend. 

If you’re concerned about giving up control to outside investors or placing a sell-by date on your company, consider offering your management team a chance to buy you out. The team may be able to finance its equity acquisition with a combination of personal funds and bank debt, borrowing against the business’s assets and cash flow. Management will be personally responsible for repaying any senior debt. If more funds are needed, subordinated debt also may be available. 

This type of leveraged recap, however, isn’t appropriate for every business. Companies need a strong management team that’s financially and emotionally committed to the future of the business. They should also have a history of profitability, low debt, solid growth potential, predictable cash flows, adequate collateral and low future capital expenditure requirements.
If you and your management team choose this type of transaction, your company will be highly leveraged. This can make it vulnerable to general economic or industry downturns, so fiscal responsibility is essential. Also, it may be difficult to find additional financing for future growth ventures.

How to Choose

The viability of either leveraged recap method depends on many factors. These include your liquidity objectives, your management team’s commitment to the future of the company, your family’s interest in running it and your business’s general financial health. 

You also need to consider personal issues. For example, how involved would you like to be in your business’s future? How much retirement income will you require? What are your estate planning goals?

Answers to these questions — and input from your advisors — will help you make the best choice.