Aleveraged recapitalization of one’s
business provides liquidity for owners while retaining ownership and management control.
Typically, the three key elements in
obtaining financing for a leveraged recapitalization are consistent cash flow, a strong
business plan and a solid management
team. With these components in place, it is
often in an owner’s best interest to do a
recapitalization rather than sell the business outright.
“Leveraged recapitalization offers business owners looking for personal liquidity
some significant, distinct advantages over
the sale of their business to a private equity firm or to a strategic buyer,” says Mike
Silva, senior vice president and group manager of Comerica Bank.
Smart Business spoke with Silva about
leveraged recapitalization, how companies
can benefit from such a transaction, and
why more and more companies are taking
advantage of recapitalizations.
What is leveraged recapitalization?
A leveraged recapitalization involves a
bank or other financing source lending
money to a company to finance a distribution to owners so they can diversify their
net worth. If you look at the typical business owner who owns a $40 million revenue business, the bulk of his or her assets
are tied up in the company. He or she typically has the company and a house, but no
other significant liquidity. Leveraged recapitalization allows owners to take cash —
often a significant amount — out of their
business and put it in the market and have
it professionally managed.
Who are the best candidates for leveraged
recapitalization?
The best candidates are companies that
are established and have consistent, stable
cash flows demonstrated over a period of
three to five years. Generally, they have in
excess of $20 million in annual revenue
and/or an EBITDA (Earnings before
Interest, Taxes, Depreciation and Amortization) greater than $5 million. Also, it
helps if there exists some level of assets
that can be used as collateral within the
business.
How can a company benefit from leveraged
recapitalization?
Leveraged recapitalization allows owners
to take some money off the table without
selling the business in its entirety or losing
an interest in the business to a private equity firm. In many scenarios, private equity is
a good avenue for obtaining liquidity.
However, owners will end up with just a
fraction, or possibly none, of their company, which will be controlled by outsiders.
Leveraged recapitalization is a way for a
business owner to realize liquidity while
still retaining 100 percent control of the
business. Also, the financing process is
quick: typically six to eight weeks. Finally,
this type of financing can be done discreetly and with confidentiality, which means
that day-to-day operations will not be
impacted and morale will not be affected.
In what ways does leveraged recapitalization
differ from private equity financing?
Typically, if a company were going to
explore an outright sale to a private equity
firm or a strategic buyer, it would hire an
investment banker who would put together a book. The investment banker would
then market the book to get as many potentially interested parties as possible. Soup to
nuts, the auction process would take a minimum of six months. And over this
time, there is a book on the street. Competitors and employees know that the business is for sale, which can negatively impact client relationships of the company
and potentially demoralize the employee
base. Doing a leveraged recapitalization
provides liquidity to the owner, but is much
more discreet. In all likelihood, the business owner, his or her financial advisers
and the bank are the only parties that will
be aware that financing took place.
What risks are involved in leveraged recapitalization and how can they be mitigated?
Any time you put additional debt on a
business, its cash flows are stressed. After
the recapitalization there will be requirements on the cash flow that weren’t there
before. This can cause liquidity problems
as well as hamper a company’s ability to
grow. Everyone involved with the transaction needs to feel comfortable that the
amount of debt put on the company is
workable, both in a best-case scenario and
a downside scenario.
Why has the use of leveraged recapitalization increased over the past decade or so?
Historically, leveraged recapitalization
was frowned upon by commercial bankers
and institutional investors. The concept of
a business owner taking a considerable
dividend out of a company’s holdings generated concerns that there would be a loss
of interest in day-to-day operations.
Lately, however, the fears associated with
leveraged recapitalization have largely dissipated. Banks have become more comfortable with cash-flow lending: lending
without underlying asset support. Recapitalization transactions have increased
more than 1,000 percent over the last nine
years, from $4 billion in 1997 to $49 billion
in 2006. In the past, the only way for a mid-sized business owner to get liquidity was to
sell the business to someone else. Leveraged recapitalization allows a business
owner to leverage the company while
retaining management control.
MIKE SILVA is senior vice president and group manager of
Comerica Bank. Reach him at [email protected] or (415)
477-3274.
