31 Dec Why are Recapitalizations a Great Alternative for Some Owners?
Have you considered a recapitalization for your business? In case you aren’t familiar with this term, a recapitalization (or “recap”) is the process of changing a company’s capital structure. The capital structure – debt and equity – is how a firm finances its growth and operations. Debt refers to borrowed money and equity is fractional ownership in the business. Therefore recapitalization can consist of replacing part of the equity with debt or replacing part of the debt with equity.
In the case of a private equity fund buying into a privately held company, it’s called a leveraged recapitalization. Often a leveraged recapitalization takes place when business owners want to enjoy some of the financial rewards of the business that they have built and the majority of their personal net worth is tied up in the company. The owner may not be ready to sell the entire business, and in many cases, shareholder agreements impose regulations that do not allow the owner to simply exchange part of their ownership for cash.
Why might a recapitalization work for you? It would mean that instead of selling the entire business before the time is right, a recap can enable you to free up financial liquidity while staying in the business with some degree of ownership. Thus, you wouldn’t need to give up complete control. Further, it would not be necessary to try to sell the entire business before it has reached its potential and you have properly prepared it for sale. Furthermore, having an equity partner may help you position the company for growth with more resources and management depth.
A Variety of Options
There are different ways to do this ranging from a modest deleveraging to sale of the majority of the company’s equity to an outside investor. In these cases, there is not only an initial payout, but also the possibility for a future pay-out.
There is also a debt recapitalization which replaces equity with debt. This process offers liquidity right away. However, since interest and principal payments are now part of the equation, this option usually works best for companies that have robust cash flow. In this case, the owner usually can keep complete ownership, while enjoying an immediate cash payment.
A recapitalization often includes exchanging one type of financing for another. For public companies, this restructuring may take place to avoid a takeover. In the case of a hostile takeover, a leveraged buyout is initiated by an outside group. This is another form of recapitalization.
The Importance of Advisors
As you can imagine, the options for recapitalization are vast, and it can be a tricky proposition to find the best fit for you and your business. That’s why it is highly recommended to work closely with advisors like Austin Dale Group to make sure your needs are met and everything is structured properly.