How to Raise the Capital you Need and Remain in Control
Private equity funds offer a way to get an infusion of capital (and additional business acumen) for your company for a period of time, while letting current management maintain a leadership role in its operation and avoiding a sale to a strategic acquirer.
It’s called equity recapitalization, and it typically involves selling a minority or majority stake in your company to a private equity (PE) group. PE firms raise money from institutions and high net worth individuals and generate returns for those investors by investing in private companies. PE professionals are typically involved only at the Board level of their portfolio companies and thus rely on management to continue to lead the company day-to-day.
With an equity recap, you receive cash proceeds for the equity sold, retain a meaningful equity ownership position going forward, and remain involved in the daily operations of the company. Following a period of growth that typically averages five years, the equity fund will need to sell its ownership stake in order to return capital to its investors. At that time, a second deal is arranged with the equity firm that may involve you:
- Selling all of your remaining stake alongside the PE’s exit to a third-party buyer.
- Selling a portion of your remaining stake and “rolling over” the remaining equity into the next deal with a new PE firm.
- Buying back the equity stake from the PE firm and regaining full ownership.
Equity Recap Benefits
An equity recap can offer multiple advantages, including:
- Diversifying your personal wealth.
- Obtaining an influx of capital to support growth.
- Allowing you to retain operational control and maintain the company’s culture and identity.
- Gaining access to the business networks and operational expertise of the PE partners to expand the business.
- An opportunity for you to recognize significant future equity returns (the proverbial “second bite of the apple”).
Despite the advantages, however, if you consider an equity recap, you should proceed carefully with professional help both during the initial transaction and the subsequent resale. There are two pitfalls in particular that you want to clarify, both regarding ownership:
- If retaining control of the business is crucial, you must make that fact clear early on in the search process. Most private equity firms require a majority position for their investments, though there are funds that focus on making minority equity growth investments.
- You must be comfortable operating in a leveraged environment. Most PE groups utilize some level of debt alongside their equity contribution to acquire their majority stake and cash flow from the company is used to service this debt. While this is the most efficient use of capital for the shareholders (including the business owner), it does increase the fixed costs of the business.
Seek Expert Guidance
One of the most important steps when considering an equity recap is to seek expert guidance in the following areas:
- Determining the value of the company.
- Finding an intermediary who will explore investment interest in the private equity community.
- Performing due diligence when it comes to potential private equity partners.
- Clarifying the tax implications of potential debt and equity recap structures.
- Structuring the private equity recap transaction.
- Establishing a plan for growth following the private equity investment.
Choosing Partners Wisely
Astute business owners will engage an independent pre-transaction advisor to serve as an “owner’s representative,” providing unbiased advice on how much your company is worth and when your company is ready to pursue an equity recap. The pre-transaction advisor can also help you choose which deal professionals to engage, including an M&A attorney to document the transaction and a business broker or investment bank to help market the company to the appropriate PE funds and ensure confidentiality of the process so as not to alarm customers, employees, or competitors.
A pre-transaction advisor will help you interview brokers or investment bankers to find a trusted intermediary you enjoy working with who has:
- Knowledge and experience with equity recaps and with businesses in your industry.
- Contacts and understanding of investment criteria with the private equity community.
- An understanding of the tax and dilution implications of various debt and equity structures.
Another important element of an equity recap is to ultimately select a financial partner who shares your vision for the company, because the private equity fund will play a key role in future growth. It is also vital to consider how well the personalities will mesh on both sides in the years to come. The current management of the company must feel comfortable interacting on a regular basis with the team from the private equity fund, as it will be a partnership going forward, regardless of whether a majority or minority stake is acquired.
Once the private equity firm is selected and a value for the company is determined, due diligence is performed, the legal purchase documents are negotiated, and a closing date is set. The typical process generally takes four to six months to complete.
Bottom line: An equity recap is a complex transaction that takes several months to complete and creates a partnership between the business owner and the PE firm that has a finite time horizon. Equity recaps continue to gain popularity among business owners who have found it a preferable path versus selling their companies outright or merging with other corporate entities.
We help clients navigate the most important challenges impacting their businesses.
Jonathan Brabrand is a Managing Director at The Fahrenheit Group and brings a unique skill set to the firm based on his 20-year career in middle market investment banking. Having represented dozens of companies in successful sale processes during his tenures at premier firms such as Harris Williams & Co. and BB&T Capital Markets, he now provides independent pre-transaction advisory services to entrepreneurs, business owners, and Boards of Directors to help them evaluate and prepare for future liquidity events, including M&A transactions, leveraged recapitalizations, or capital raises. He also works with executives to hone their business plans, develop acquisition strategies, and refine their company’s core value proposition. His experience-based advice on liquidity alternatives, timing, valuation, and overall transaction readiness focuses solely on the owner’s best interests and lacks the inherent bias from business brokers and investment bankers whose ultimate goal is to secure an advisory mandate. d: 804-823-3916 | c: 804-334-3698 | e-mail:firstname.lastname@example.org