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Recapitalization: Pros and Cons

Business Sales and M&A Specialists

Recapitalization (recap) is a partial sale of a company that allows the owner to liquidate some of the value they have in their business. Typically, this involves selling equity (usually 70-80%) to a third-party, however some business owners do sell just a minority stake.

Recapitalizations are a standard investment tool used by Private Equity firms. They have investor dollars that need to be put to work and a timeline in which they’re expected to deliver returns. This means, they buy businesses with the intent of growing them and/or repackaging them with synergistic businesses for resale approximately 5 to 7 years down the road.

Using this playbook, they generally prefer to buy businesses with an active owner or strong management team in place. You or your existing leadership team will continue to run the business day-to-day with the private equity investor providing resources and assistance to fuel new growth.

Pros/Potential Advantages:

Liquidity: As a business owner, you may have all your financial resources tied up in the business. A partial sale allows you to take some chips off the table, securing your financial future.

Business Professionalization: Recapitalization can have the effect of increasing management rigor. Your investment partner may help you implement new reporting practices, processes or management software. While these tools help you remain accountable to your new partners, they can also help the business make more informed, data-driven decisions and increase value for a future sale.

Growth Partner: If there is a growth opportunity, but you are not prepared to take on new debt or risk at this stage in your life, an investment partner can provide the resources to fuel growth plans. For example, a physical therapy business owner had grown his business from a single clinic to 50 over the course of 20 years. After partnering with private equity, the business doubled to 100 locations in just 2.5 years. He did what he loved, integrating new clinics, while the investment team focused on acquisitions. When he sells his remaining equity in the business, his minority stake will likely sell for a much larger value than what he received in the initial sale.

Cons/Potential Disadvantages:

Slow Exit: If you are burned out or ready to retire NOW, this is generally not the right approach for you. In a recap model, the investors are typically looking for a business leader who will stay for roughly five years. That won’t work if you don’t have any gas left in the tank. However, this approach could work if you have a strong management team. Equity can be transitioned to management, creating a new group of minority owners motivated to drive success.

Less, if any, Control: While you will still run the day-to-day business, you will no longer be the primary owner and decision-maker. Your investment partner will be involved in all significant financial and strategic decisions. Thus, before you partner with an investment firm, make sure you feel like your goals align with their intentions. Do your Due Diligence and talk with other business owners they’ve partnered with in the past, to find out how well the relationship worked out.

Growth Pressure: If you’re being recapped late in the life of an investment fund, your investors may need to show returns in just a few years. This may lead to a situation in which you’re pressured to grow quickly as your investors may be more interested in short-term returns than long-term strategic growth. Then again, if your investor is looking to sell quickly, one concentrated push with a faster exit might appeal to you.

At the end of the day, recapitalizations may be a great tool to grow your business and increase your overall value. Finding the right partner takes careful consideration and due diligence. But with the right fit, you can often accomplish more and reap greater rewards than with a traditional full sale.