For privately-held business owners, selling their business will be one of the most important decisions they will ever make. They only get one chance to put a price tag on years of effort. The decision to sell can be affected by many challenging issues, some of which can be alleviated by a recapitalization. A recapitalizaton is a transaction where the owner sells a majority of the business to a private equity firm for cash while maintaining an ownership interest – typically 10 percent to 30 percent - that fits their risk appetite. This allows business owners to diversify their personal financial risk while retaining some of the business’s upside potential. In addition, a recap potentially affords owners more non-economic benefits compared to either continuing to run the company or selling the entire company to a strategic buyer.
Economic Benefits
For many businesses, a “recap” makes better economic sense than a 100 percent sale. Specifically, for companies with significant growth and profit potential, but inadequate capital and management resources to fully capitalize on the opportunity, a recap is an ideal strategic solution. Partnering with a private equity firm provides the owner with access to capital and managerial resources and allows the owner to “piggyback” on a private equity firm’s experience at creating larger, more profitable and more strategically significant businesses. Since a growth-oriented private equity firm seeks to double or triple the size and value of the company during the course of its ownership - typically five to seven years - when they exit, owners can transform their minority interest into another significant payday. The owner’s combined proceeds from a recap often exceed what they would have enjoyed had they initially sold the entire company.
Non-economic Benefits
In addition to superior economic potential, a recap offers owners the following benefits:
Legacy in the Community - Often a primary concern for owners is the company’s continuity and its place within the community going forward. A recap accomplishes this objective since private equity firms generally have a strong desire to retain the existing operations and workforce. In fact, many private equity firms make a purchase conditional upon much of the workforce and key employees remaining in tact. In addition, a by-product of the company’s growth is new jobs and enhanced career opportunities for the employees. In contrast, a sale to a strategic buyer often results in the company being downsized and merged into existing operations.
Access to Capital - Often, as owners approach retirement, investment in the business gets curtailed as they become more risk averse and prefer to diversify their personal balance sheet. A growth-oriented private equity firm provides the company with immediate access to growth capital for new capital equipment, internal growth opportunities and strategic acquisitions.
Access to Management Resources – In many instances, growth is hindered when a company’s growth and complexity outstrip management’s capabilities. A private equity firm generally employs or has access to former CEO’s, COOs and industry experts that can assist with strategic planning, international sales and sourcing, technology, and operations. In addition, private equity firms generally help put in place the planning, budgeting, human resources, information systems and corporate finance infrastructure necessary to grow the business.
Other potential benefits of a recap include:
The elimination of personal loan guarantees;
The likelihood that the private equity firm will create an equity program to allow key executives to become shareholders. In addition, private equity firms generally award performance-based incentives to attract and retain high-performing employees;
The ability for the owner to continue to be involved in the business in the same or modified role.
Happ Controls, L.L.C
A successful recapitalization can rejuvenate a company both financially and within its culture. Case in point, Happ Controls. The company, headquartered in Elk Grove Village, Ill., was founded in 1986 and has grown to become North America’s largest manufacturer and distributor of parts for the amusement, vending and gaming industry. Frank Happ, the founder and owner, recently sold a majority of his business to Pfingsten Partners, L.L.C., an operationally-oriented private equity firm based in Deerfield, Ill.
Frank Happ, the founder and majority shareholder of Happ Controls, was approaching retirement and sought to “take some of his chips off the table.” Fortunately, the time was right as revenues and profits were at an all time high. Because of the company’s success and growth, Happ faced challenges typical of owner-operated companies, including determining how to broaden the company’s product line, increase international sales, leverage foreign sourcing opportunities and increase operating efficiencies. In addition, he recognized the need for additional capital to sustain the existing internal growth and provide for opportunistic acquisitions. Also, the company’s growth had created a need for more professional management practices, from quality control to financial planning and reporting.
Pfingsten Partners acquired a majority of Happ Controls, with Frank Happ assuming the role of Vice Chairman and retaining a minority interest. Tom Happ, then Vice President of Sales and Marketing, became the company President.
According to Tom Happ, “Our partnership with Pfingsten Partners has created opportunities for us that were previously unavailable. First, by way of background, we historically focused on revenue growth as the key driver to increased profitability. Now, while we still focus on revenue growth, we’ve also put in place the professional management practices and information systems to scrutinize margins. As a result, we’re on pace to achieve our goal of doubling operating margins within two years. Meanwhile, quality, on-time delivery and customer satisfaction are at an all time high.”
“Second”, added Happ, “we completed the merger with Suzo International, our European counterpart, late last year. The combination makes us the dominant global player in our industry and offers tremendous synergies related to sourcing, product line, distribution channels and sharing of best practices. Without the capital provided by Pfingsten, the transaction wouldn’t have been possible. Not to mention that we had little experience in doing an acquisition or integrating companies post closing.”
Added Happ “However, I think the most important change came at the employee level. Previously, our decision making was very centralized. Now, we have a company-wide team-based continuous improvement program that encourages and rewards all employees for their input relating to how to improve the value we bring to the customer. They feel empowered and recognize their importance to our success. While they were initially and naturally worried about how the change in ownership would affect them, they are now energized and have a refreshed attitude and commitment to their job. Most of our key managers have an equity interest in the company and as we grow, they’ll profit and all of our employees have more career options. Being able to positively affect the day-to-day happiness of our dedicated workers has turned out to be one of the biggest pluses – and one that we frankly didn’t foresee.”
As this example helps illustrate, successful recapitalization transactions are often built upon a positive and dynamic relationship between the business owner and the private equity investor. Many middle market companies have significant growth and profit potential but lack adequate capital, resources and experienced outside counsel.This leads them to a cross-road where a recapitalization can be a successful means of creating a more profitable and competitive business.
To learn how your company can benefit and best position itself within the M&A landscape, call or email me now to receive 3 hours of free consultative analysis. Our analysis offers clarity, based on your objectives, if a full or partial exit, recapitalization, divestiture, acquisition or pre-sale exit strategy provides the greatest benefit to you and your company.
Vercor has been delivering M&A expertise for over 25 years. We serve as a trusted partner to help build long term, iterative strategies that ensure you are positioned to meet your unique personal and financial goals whether it is selling, recapitalizing, acquiring or divesting of a division. Now is the time to evaluate, strengthen, prepare and increase the market value of your company regardless of your timeframe.
Todd Cummiskey
Vercor
704-926-6564
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