Taking some chips off the table

For business owners with significant wealth tied up in their business, a recapitalization can be a way to realize some of that value today and potentially increase the value of the company for a second round in the future.

There is an option available to many business owners that could allow them to realize some of the value inherent in their business today while continuing to maintain a stake and operational role in the company.  Through a recapitalization with a financial partner, business owners can sell a portion of the business now and sell the rest in the future when the financial partner exits. 

The advantages of a recap include: lowering the risk of mistiming the sale of the business, bringing in a partner that can help grow the company, and potential tax savings.  And a recap does not mean that you will no longer run the company.  Having the existing management team stay in place and continue to handle day-to-day operations is usually a key requirement for financial buyers.

Do you have most or all of your wealth tied up in your business?  This is not an uncommon situation for business owners.  The end goal may be to realize this value through the sale of the business when the time is right.  But when is the time right? 

Many business owners that planned to sell during the past several years found that the effect of the economy on their business and the acquisition market forced them to make new plans.  Through a recap the owner can realize two separate sale events over time which can help alleviate some of the risk associated with the timing of the sale of the business. 

After investing in a recapitalization, private equity and other financial partners are motivated to increase the value of their investment.  This is how they make money.  Private equity firms have operational experience and tools that a business owner may not possess.  They are generally very good at upgrading systems to help a business run more efficiently. 

They also typically have industries in which they prefer to focus.  Within these industries they have specific knowledge and contacts that can help accelerate growth.  Financial partners also have the experience and capital to grow companies through additional acquisitions.  These focused acquisitions can add value by bringing in additional scale, customers, and/or complementary lines of business.

One current motivating factor for taking some value out of a business relates to the impact of tax rate increases in 2013.  The existing 2012 federal capital gains rate is 15 percent.  The capital gains rate in 2013 is set to increase to 20 percent and there will be an additional Medicare Contribution tax of 3.8 percent.  It is worth comparing the potential tax savings from a sale this year with the additional value that might be realized in a future sale.

For business owners with most of their wealth tied up in their business, a recap can be a tool to spread the risk that comes from selling the entire company at a given point in time.  According to Pitchbook, private equity investors were sitting on $425 billion in uninvested capital in 2011.

Pitchbook statistics also show that private equity deal volume and valuation multiples have increased over the past two years.  You may not consider this the perfect time to sell your business but maybe it is a good time to take some chips off the table and take on a growth partner that will help increase the value of your business for the next round.

Categories: Company Perspectives, Finance