Recapitalize Your Company? For and Against.

http://journalrecord.com/2011/11/09/recapitalize-your-company-for-and-against-part-i/

http://journalrecord.com/2011/11/16/ma-blog-recapitalize-your-company-for-and-against-part-ii/

The links above are to the articles as published in the Journal Record.

POSITIVES

1) Securing the Value of your Company

Let’s say you owned a company that you had started from scratch twenty years ago, that was now worth a considerable amount of money if you were to sell it. Each year that you continue owning 100% of the Company, you have 100% of the value at risk. If the Company were to double in value, you double your investment, but the downside is equally great. For many business owners, there comes a time when they would like to reduce that risk.

Whether a business is worth $10 million or $100 million today, a business owner may feel that it is time to protect their wealth, secure their personal assets and lock down financial security for their family. There may be an opportunity to grow sales and earnings in the coming years and exploit new market opportunities, but it can be extremely challenging and tiring to compete in a business year after year, especially if you have a limited time horizon before retirement.

In many cases, harnessing the value in a business is about timing and making a decision to recapitalize at the right time maybe only occurs every 3, 5 or 10 years. You may not want to wait around for the next opportunity. It may be the smartest decision for a business owner who has been risking everything for decades to take stock of their investment and determine how much of that value they’re willing to risk.

A recapitalization fulfills that need as it gives you the possibility of taking cash out of the business, by selling a minority or majority stake in your company.  It may even be an option to consider a few years ahead of retirement, as the first step in the process of selling your company. As an owner, you get to take cash off the table, reduce your risk and diversify your investments, securing your family’s future, while still having an upside opportunity to continue making money and capital gains from valuation increases in your business.

2) Bringing in a Capable Partner

If you pick the right partner in an equity recapitalization (we’ll spend time next week talking about the implications of not picking the right partner), you benefit from their financial, strategic and operational strengths and fresh perspectives.

When they make a considerable investment in your business, they also demonstrate the tremendous value they see in the way you are doing business, but both parties need to share the same vision for future growth. If this is the case, you can have a situation where the combined value of the new partnership is worth more than the sum of its parts. You may be freed up to pursue growth opportunities that you haven’t previously had time to focus on and spend your time in the parts of the business that you love, while your partner takes care of other parts of the business that you would otherwise have overseen. However you want to structure this is up to you.

3) Stabilizing the Capital Structure

In certain businesses, there can be substantial fluctuations in the cash needs and capital expenditure required to run a business.

Undertaking a recapitalization can stabilize your firm's capital structure and cash position. This can be achieved by bringing in additional equity to the company, negotiating revised terms with lenders, trading existing debt for new debt with lower rates or longer maturity, exchanging debt for stock, or any number of alternative strategies.

NEGATIVES

1) Bringing in the wrong partner

It is critical to take time to conduct the right research and due diligence to identify the best partner for your business. If there are multiple parties willing to invest in your business, the price and structure for the investment is clearly important, but finding the right partner is more important. An additional 10% or 20% in terms of business valuation today may have little value in a few years if you have disagreements over the strategic direction of your business. You should investigate your prospective partner’s previous experience, track record, credibility, motivation and financial stability. The right partner should not be offended by this investigation, but instead impressed by the thoroughness of your research.

2) Increasing Management Discipline

Bringing in a new partner will sometimes increase a company's debt leverage. While this could have a positive disciplining effect on management and decision-making processes, it also restricts the flexibility that a business has and imposes certain financial constraints. While the aim of a recapitalization should be to improve a company’s capital structure, it is only a tool and in the wrong hands can be misused. Increasing debt leverage will bind your business to financial covenants in the credit agreement and place restrictions on investments and distributions to owners. Furthermore, costs can often increase if lenders start charging monitoring and maintenance fees on the loan.

3) Loss of Control

New equity partners are going to be involved in important strategic and financial decisions. The extent of their influence is governed by the capital structure and terms of the agreement that you sign with them, so it is critical to have the structure negotiated on your behalf by experienced advisors and transaction attorneys, who can clearly explain the implications of the new partner’s involvement in decision-making processes, along with any effective veto or other override powers they may have. For your part, it is also a good idea to talk to other entrepreneurs who have partnered with them to learn from their experiences.

If you do the hard work up front, it can be a great experience, but you are only likely to get out what you put in. In some cases, equity investors could focus too much on short-term financial performance, with little understanding or appreciation of the business and industry that you’re in. Instead, you want to identify the partner who can clearly show that their strategic vision, expectations and timeline are in line with your expectations.

In summary

There is a lot to consider when considering a recapitalization and we would urge you to talk to experienced advisors to walk you through the process and assist you when needed. Recapitalizations are a great tool, but only in the right hands.