A few years ago, private equity recapitalization was a small percentage of the
way owners exited their businesses,but today, its popularity is growing fast.
“Sixty to 70 percent of what we do now
involves private equity firms,” says Joel J.
Guth, an advisor in the Citigroup Family
Office at Smith Barney. “It is a very attractive option. You can continue to work for a
few more years but also secure your financial future by taking a good amount of
money out of the business today.”
Smart Business asked Guth questions
about the best way for an owner to exit his
or her business by using a private equity
firm.
What kind of companies do private equity
firms consider recapitalizing?
They want to bring some expertise to the
table in terms of access to capital, new
ideas and access to sophisticated, savvy
investors who will help the company grow.
To that end, they look for well-run businesses with strong ownership that is willing to stay in place for three to five years
and an experienced management team.
They want the company to be in a good
industry that has attractive growth with
historical, strong, consistent profitability.
Contrary to what you might expect, private equity firms prefer not to interfere
with the integrity of the business, which
usually means that employees can stay in
place, job descriptions and responsibilities
will not change, and employees will still
report to the owner. They do not want to
get into the business of running companies
on a day-to-day basis. When they conduct
their due diligence upfront, they are looking for a good partner.
What kind of owner can benefit from private
equity recapitalization?
Consider an owner in his late 50s who
would like to retire in three to five years. He
has a good business and a fairly large net
worth. He knows he can continue to grow
his company, but he has to infuse capital —
without risking his own financial future.
With a private equity recapitalization, the owner typically retains 10 to 30 percent of
the business. The private equity firm will
create a very lucrative stock option plan
for the senior management team, so that if
the company can realize its growth plan
and stay profitable, senior management
will be able to take money out.
What are the inherent dangers to using this
option?
One, there is a potential loss of management control, both financially and operationally, because the owner is giving up
majority ownership in most cases. Two,
somebody will be scrutinizing results and
possibly questioning the owner’s management — and that can be tough for a lot of
entrepreneurs. And three, there are potential conflicts in culture and chemistry. If
results start to suffer, investors are going to
want more of a voice in how the business
is run. They could even ask the owner to
change long-held policies and practices.
What happens to the company when the
owner does call it quits?
In that three to five years, the private
equity firm is hoping to sell the company
again, at which time, the owner will retire fully. If the owner wants to retire prior to
that, the private equity firm would work
with the owner on a succession plan.
Normally, owners want to stay until that
second liquidity event because they still
have their money invested in the business.
How does an owner find a private equity firm?
Most owners are getting phone calls
every week. Very rarely will an owner get a
maximum price for the company by talking
to one private equity firm because it is trying to buy the business at a price that will
maximize its return. The best way for the
owner to realize his objective is to create a
competitive auction process with four to
five prospective buyers. If the auction is
run correctly, it will increase the sale price.
However, when choosing a private equity
firm, the money is only one consideration.
The second is finding a high level of comfort. If you can get the right match, your
odds of success at eventually exiting the
business in good financial shape go up dramatically.
Citigroup Family Office is a business of
Citigroup Inc., and it provides clients
with access to a broad array of bank and
nonbank products and services through
various subsidiaries of Citigroup, Inc.
Citigroup Family Office is not registered as a broker-dealer nor as an investment advisor. Brokerage services and/or
investment advice are available to
Citigroup Family Office clients through
Citigroup Global Markets Inc., member
SIPC. All references to Citi Family Office
Financials Professionals refer to employees of Citibank. N.A. or Citigroup Global
Markets Inc. Some of these employees are
registered representatives of Smith
Barney, a division of Citigroup Global
Markets Inc., that have qualified to service
Citi Family Office clients.
Citigroup Global Markets Inc. and
Citibank are affiliated companies under
the common control of Citigroup Inc.
JOEL J. GUTH is an advisor in the Citigroup Family Office at
Smith Barney, a division of Citigroup Global Markets. Reach him
at (614) 460-2633 or [email protected].
