For business owners looking to unlock potential illiquid value in their business, but also want to retain ownership, a leveraged recapitalization could be the right strategy.
It may come as a surprise to learn that many business owners do not have a succession plan—and yet, in the 2015 Middle Market Business Leaders Outlook, 42 percent of those surveyed say their companies have no formal succession plan in place. And as owners get closer and closer to retirement, it becomes more essential than ever to start thinking about what lies ahead for you and your business.
“42 percent of middle market companies surveyed say their companies have no formal succession plan in place”
Each ownership-transition strategy offers its own unique set of benefits and disadvantages, but for those seeking an option that provides increased liquidity for an owner who wants to continue working with the business, there’s one option that should be at the forefront of any discussion: a leveraged recapitalization.
What Is a Leveraged Recapitalization?
In a leveraged recapitalization (leveraged recap), a company partners with an investor—such as a traditional bank, hedge fund, insurance company or private equity firm—and takes on debt in exchange for equity. This could provide the business with the capital it needs to repurchase shares or pay out dividends to its shareholders without having to relinquish company ownership.
However, the deal structure may require the owner or owners to give up a minority interest in the company to the investor. Additionally, it’s possible that the investor’s minority interest may be accompanied by a board position or board observation rights, which can be an undesirable situation for those who aren’t used to collaborating with an outside partner.
One of the potential benefits of a leveraged recap is that it could provide owners with the ability to unlock the business’s potentially illiquid value. But by its very name and nature, leveraged recaps increase debt, which can be a risky choice. And the liquidity distribution, which might be good news to owners and other shareholders, comes with a potential tax burden.
Is It Right for You?
If the potential risk that accompanies additional debt doesn’t faze you, a leveraged recap may be an option you’ll want to consider. For an owner who isn’t ready to retire, who has built significant value in their business and who is looking for an opportunity to unlock some of that value to repurchase shares or pay out shareholder dividends, it may just be an option that ticks all the boxes.
Business owners often fail to plan their financial strategy even as they move towards selling their business, perhaps the most valuable asset they have. Defoe Redmount’s exit planning team provides guidance and counsel for business owners planning to exit from company to maximize exit value, reduce transition risks, impact long-term after tax financial strategy, and grow family wealth. Learn more here or contact us for a complimentary and no-obligation review of your exit strategy assumptions and long-term goals. See if we can help you maximize company exit value, reduce transition risks, impact long-term after tax financial strategy, and grow family wealth.