Private equity funding is a transaction that can provide liquidity and
growth capital to an owner who doesn’t want to sell the business, but
does want to realize some of the benefits
of a sale or merger.
“Private equity funding can benefit
owners by giving them a significant portion of the value of the business in cash,
while maintaining an ownership interest
in the recapitalized company going
forward,” says Bob McDonald, CPA,
CM&AA, a principal with Briggs &
Veselka Co.
“The transactions are usually conducted with a private equity group that contributes equity to recapitalize the company.”
Private equity funding can divide a
company’s equity into two or more classes, with provisions to serve the objectives of the owners. The owners grow
the business, while the financial partner
provides assistance on financial, strategic and exit issues. At a later date, usually five to seven years, the company could
either be sold to another firm, go public,
or undertake another recapitalization.
Smart Business spoke with McDonald
about private equity funding and how it
can offer benefits to all parties involved.
For whom is private equity funding best
suited?
Private equity funding allows owners
to achieve personal liquidity without
sacrificing the operating control of the
company they built. Through a recapitalization, a portion of an owner’s equity is
sold to the private equity group (either a
minority or a majority interest), while
maintaining operating and ownership
control. This scenario is an alternative to
total sale or regulatory scrutiny of a public offering. The owner is able to gain a
financial partner to assist with strategic
issues without interference in day-to-day
operations. With its access to substantial financial resources, the financial partner
supports the company in expansion
plans and/or pursuing strategic acquisitions. By selling a portion of the company, the owner can eliminate personal
guarantees on company debt, diversify
net worth, and continue to run the company, if they choose. This newfound ability to grow increases the value of the
owner’s retained equity position. Private
equity funding is an excellent option to
facilitate the owner’s estate planning and
execute a succession plan to either the
next generation or management.
What about retaining key employees?
Non Qualified Stock Options (NQSO)
are great ways to help retain key
employees. Even if a private equity
group is not involved, NQSOs should be
considered as part of an owner’s exit
strategy. The goal of a private equity
fund is to build value, therefore the
investors expect a high rate of return on
their acquisition. While they are very
experienced in business, the private equity group does not typically have the
operational experience needed to efficiently run the acquired business. For
that reason, the investors generally
retain the owner and key employees. In
contrast, if an owner sold to a competitor, the new buyer may not want to
retain these employees.
The company can grant NQSOs only to
the employees it chooses. The options
are not taxable to the employee until the
option is exercised. At the time, the
employee recognizes income equal to
the fair market value of the vested
amount, and the company receives a
deduction for the amount. A good tool is
to grant NQSO on a vested schedule. If,
for example, an employee is to be granted 5 percent of the stock, vesting at
1 percent per year, the employee has an
incentive to stay with the company for at
least five years.
Why would I want to give ownership to my
key employees?
Assuming the company is successful, it
is probably in the 35 percent tax bracket.
Since the company receives a deduction
for the value of the NQSO, it is saving
35 percent of that value in taxes. The
remaining 65 percent should be considered as an investment in the company.
By giving ownership in the company, the
employees will maximize their efforts to
help the company grow and become
more profitable; the owner’s return on
his remaining ownership may far exceed
the value of the stock granted. This is a
decision that has to be carefully
weighed, but can be a very good investment in your own company under the
right circumstances. <<
BOB MCDONALD, CPA, CM&AA, is a principal for Briggs & Veselka Co. Reach him at (713) 667-9147 or [email protected].
