Is 'Leveraged Recapitalization' Option for Owner Transition?

NewSpring Mezzanine

This article was first published by Corp! Magazine.

Entrepreneurs invest a great deal of sweat equity and personal resources into nurturing and growing their business, so it’s only natural to want what’s best for the next generation of their company – as well as their own future.

In some cases, this requires a business owner to obtain a certain amount of capital in order to take the next step forward. While there are many strategies to achieve this goal, a mezzanine leveraged recapitalization might make the most sense.

What exactly is a leveraged recapitalization? At its core, it’s when a company partners with a private equity mezzanine investor, who in return provides financing that can be used at the business owner’s discretion; including funding a transition of ownership or generating liquidity for personal reasons.

As collateral, these debt obligations are often dependent upon the future cash flow of the business. Therefore, ideal candidates for a leveraged recapitalization will have a steady history of predictable cash flow with low levels of existing debt on their balance sheets.

To help better illustrate the concept, let’s consider a few examples of when a mezzanine leveraged recapitalization could be the smart choice.

An entrepreneur owns a profitable company, but much of his net worth is tied up in the business and illiquid. After years of hard work, he decides it’s time to take some chips off the table and diversify his personal portfolio risk.

However, he is still very much involved in running the company and isn’t ready to sell his business or relinquish an equity stake, which might mean ceding some control. In this situation, a leveraged recapitalization allows the business owner to diversify away some personal risk, while continuing to control and run his business.

In addition to providing some liquidity of ownership in the business, a recapitalization also releases the owner from carrying personal guarantees on the company’s debt – making this a potentially attractive strategy.

Another example would be a business where the owner may no longer be the day-to-day operator. If the owner wants to sell the business to the operator, perhaps a senior employee or family member, that purchaser may not have the means to fund the transaction. In this situation, a leveraged recapitalization would allow the business to borrow the money in order for the operator to take control and pay out the owner.

A leveraged recapitalization may seem like an obvious solution, so why do some business owners shy away from this strategy?

In some cases, there are business owners who are simply averse to debt and would prefer to just sell an equity stake in exchange for the capital. In other instances, businesses might not meet the specific eligibility requirements.

While these requirements may differ at each organization, an analysis of a company to determine whether or not to partner for a leveraged recapitalization is typically a first step, one that involves focusing on everything from strength of management, historic cash flow, total debt ratios and minimum revenue requirements.

One of the most important factors to be considered is whether or not a company has a sound corporate structure in place. With new debt comes new covenant compliance and financial reporting, so it’s crucial to have a strong CFO who understands how to operate within a private equity structure.

A leveraged recapitalization can be a smart solution for business owners who meet the requirements. As with any business decision, it is important for those considering a recapitalization to conduct due diligence and have a thorough understanding of the process and the private equity fund involved before entering into agreement transaction.

With the right partner in place, this strategy can provide entrepreneurs with the necessary resources needed to set themselves and their company up for financial longevity.