Investment options Featured

8:00pm EDT September 25, 2007

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 masilva@comerica.com or (415) 477-3274.