Business owners, particularly those who started a company from scratch, tend to have a large percentage of their net worth tied up in the company. Recapitalizations, which mergers and acquisitions industry experts say are growing in popularity, offer business owners a way to stay involved but pull a large amount of their net worth out of their company.
A recapitalization sells a controlling share of the business, but the former owner retains a smaller ownership piece.
A partial sale or recapitalization almost always sells a controlling share of the business to a private equity group. The technique has grown in popularity over the past three years because of the increased buying power and aggressiveness of private equity buyers.
Prior to 2004, strategic buyers were buying companies for higher prices than private equity groups. If a business owner wanted to keep a share of the business, they had to settle for a lower sale price because the economy and M&A market was weaker.
However, as the economy improved and more money flowed into private equity groups’ coffers, they started paying equal or higher prices than strategic buyers in recent years. In the past three years, increased competition to buy companies, increased pressure to spend money within funds and banks willing to help fund the purchase of companies have led private equity firms to pay higher prices for companies, both public and privately held.
That has led to an increase in recapitalizations, said John Beagle, managing director with Milwaukee-based Grace Matthews Inc., an investment banking firm. That increase has enabled business owners to sell their companies in stages and take part in future growth of their companies.
“Now, savvy (company owners) can have their cake and eat it too,” Beagle said. “You don’t feel like you’re bailing on the company. And there is an opportunity for management to have an ownership stake. And you get to define your job.”
Grace Matthews sold 10 businesses in 2006 with a combined value of about $500 million. About one-third of Grace Matthews’ deals were recapitalizations last year. Recapitalizations have taken up an increased share of Grace Matthews’ business since 2004.
When Grace Matthews meets with business owners, they’re asking about the recapitalization trend, according to Doug Mitman, another managing director at Grace Matthews.
“It’s sort of like the hot new flavor,” Mitman said.
“That’s what business owners want to talk about when they sit down with us,” Beagle said. “They’ve heard about it. I’m surprised at how much interest there is in it.”
A recapitalization can get business owners higher prices because private equity firms usually buy, build and sell a company within three to seven years and want to build value to maximize future profits. Recapitalizations require the owner to keep a share of the business, and when it is sold again, they’re able to cash out the rest of their portion.
If the business has doubled or tripled in value, the share they’ve left in the business could even exceed the initial sale price, Beagle said.
Recapitalizing with a private equity group also gives business owners access to the group’s employees, who often have extensive managerial and executive experience. Those executives can help plan the company’s future, Mitman said.
“A lot of business owners don’t have a succession plan,” Mitman said. “And private equity guys have experience in hiring and firing management teams. They can help you select and groom a new team.”
By recapitalizing with a private equity group, owners of small businesses may be more willing to take some risks to achieve long-term success, Beagle and Mitman said.
Private equity groups are playing the biggest role in the growing popularity of recapitalizations, said Robert Bellin, chairman emeritus of the board of directors at Milwaukee-based Reinhart Boerner Van Duren S.C. Bellin routinely consults clients on business formation, licensing, succession planning, recapitalization, acquisition and divestitures. However, real estate investment trusts (REITs) and employee stock ownership programs also have helped drive interest in recapitalizations, he said.
A partial sale often works best for business owners who have started their companies from scratch and can’t bear to step away.
“There’s always a balance between people that built a business,” he said “They can’t bring themselves to part with it, but they have a desire to take some of their money out.”
Interest in recapitalizations will continue as long as private equity buyers have an appetite for healthy companies, Bellin, Mitman and Beagle said. And private equity doesn’t show any signs of slowing down its levels of activity now – because interest rates are still low, banks are still willing to lend money and private equity groups still have large amounts of money to spend.
“It will all continue until we get a correction,” Bellin said. “The question is when and what that will be. That’s the least of our worries – we had an oil crisis, and that stabilized. The market’s back on track. One thing you can count on is that it’s something we don’t expect.”
