Minority Recaps - A great option for some business owners

     

[Editor's Note: With higher interest rates, a lower stock market, and banks more reluctant to lend, valuations for companies looking to exit have taken a hit. I thought this would be a good time to talk about minority recaps. -dpm] Many company CEOs and CFOs today are spending a good deal of time “working” the banking environment. Many of our client companies are performing at very good levels. Some are interested in taking advantage of acquisition opportunities, others in growth plans with new products and new markets. Some are looking for the opportunity to hedge the risk and perhaps take a few chips off the table. Others are good performing companies but have issues with their balance sheet. I have been surprised at how few business owners, CEOs and CFOs are aware of MINORITY RECAPS as a potential means for growth capital, taking a few chips off the table, and possibly providing for balance sheet stabilization. We recommend consideration of minority recaps.  What are Minority recapitalizations (Minority Recaps) - Owners of mid-market and family-owned companies can sell less than 50 percent of their shares at minimal, or no, minority discount and still retain control. Owners of mid-market and family-owned companies can sell less than 50 percent of their shares at minimal, or no, minority discount and still retain control; they can receive cash for their shares; they can use debt, as well as equity, to enhance returns; they can keep a significant equity tranche for a second exit when market conditions might again be peaking; and they can pursue an aggressive and ongoing business plan designed to stimulate organic growth and finance acquisitions. This allows private company owners to lower risk by lowering the personal financial concentration they have in their business through diversification.  A common myth is that all private equity firms want control. While that may have been true ten years ago, in today's environment, some PE firms are enthusiastic about teaming up with management to grow good companies with less than a controlling interest.  Minority recaps are not an appropriate for every business owner The company needs to have the following characteristics: •   Good operating performance (cash flow and revenue growth) •   Good management team •   Strategic Growth Plan (tangible opportunities for growth) For those companies that meet these parameters, it might be just the ticket. Beware – Not all minority recaps are favorable. Some PE firms will add terms that make a minority recap very onerous and function more like a control investment. It is important to have professionals on your team that understand these transactions and who know which PE firms are comfortable with minority positions.  Second bite of the apple can be better and sweeter than the first.  For those companies that sell a minority stake with opportunities to grow, the results can be compelling. In many cases, partnering with the right private equity firm can provide growth that is many times higher than the company could have achieved without outside capital. When the company is ready to sell in an additional five years, perhaps, the owner can reap significantly higher returns.  Example: A few years ago a client of ours was doing $26 M in revenue with good margins and cash flow. The owner wanted to expand beyond the region into other markets with new products but lacked the capital and financial expertise. We helped the company develop a strategic growth and execution plan and shored up some weaknesses to present the company in its best light. We assisted the company in finding experienced, knowledgeable resources to help. The company sold 35% interest to a private equity firm. The owner was able to take a few million of his chips off the table (his family was very happy that his exposure was lowered) and still had significant capital to expand. The private equity firm assisted with introductions and recommended the addition of a terrific CFO and a strong VP of Operations. After five years, the company recorded over $130M in revenue. That second bite 65% share was worth a lot more than it had been five years earlier. The owner had this to say: "I had heard terrible things about private equity. But these guys really became our partners and helped us become a better company. Thanks to Mead Consulting for helping us get it done with the right team."  Market Challenges The current market offers interesting challenges. But some companies will be able to navigate these waters and put themselves in a lasting competitive position. Think about how your company could gain with capital to acquire and grow during a period when everyone else is in the bunker with their heads down. One caution - before embarking on this path, seek help from those professionals with experience working with mid-size companies in your position. If you would like more information on minority recaps please contact me at (303) 660-8135 or meaddp@meadconsultinggroup.com Note SBA Update: For small transactions, As of August 1, 2023 there are numerous changes to the SBA Loan programs.  Among them: The SBA now permits "partial change of ownership" which provides greater flexibility for small businesses.