The Middle Market Review Insights on the Middle Market.

Subscribe Subscribe

Subscribe Today

I want to receive:

Thanks for subscribing!

Business Owners

3 Ways Sellers Should Think About Private Equity Recapitalizations


There is some misconception amongst business owners that selling to a private equity will mean a loss of control. For business owners interested in only partially selling their business and remaining involved, however, a private equity recapitalization is one compelling option. Recaps are most frequently about looking for opportunities to invest in firms and augment their growth. But beyond the implications for the business itself, a seller may see several significant benefits from opting into this type of transaction.

To understand the benefits of a private equity recapitalization, both for company outcomes and the seller, personally, a business owner should consider the following:

Two bites of the apple

One of the most compelling reasons to participate in a private equity recap is that it allows a business owner to sell a partial stake in the company initially, leverage the increased cash to fuel growth and then exit the firm completely further down the line at a potentially higher price.

Divestopedia offers a quick breakdown of what a CEO might earn if he sells in full after letting a private equity firm help him grow his enterprise value. In their example, a CEO negotiates an agreement with a private equity firm whereby the firm purchases a 70% stake in the organization at a $20 million dollar enterprise value. The buyer finances the acquisition with 40 percent equity and 60 percent debt, which will leave the company carrying $12 million in debt. While the company’s new equity value will be $8 million, its enterprise value will still be $20 million. After the CEO subtracts his remaining stake of 30 percent of the equity value – which amounts to $2.4 million – from the enterprise value, he receives pre-tax proceeds of $17.6 million.

Because most private equity firms have a time horizon of about 5-7 years to return value to their investors, it’s likely they’ll work to grow the business and reduce its debt in this time before pursuing a liquidity event. Whether the business is eventually sold to another private equity firm, goes public, or sells to a strategic buyer, the owner stands to receive the value from the remaining 30 percent he holds in the company.

In this scenario, say, the enterprise value has doubled to $40 million and its debt outstanding has fallen to $5 million, that 30 percent of the remaining $35 million equity value equates to another $10.5 million in the pocket of the business owner.

Diversifying investment

Business owners are frequently over invested in their own companies, which leaves them at risk with too many eggs in one basket. In addition, it may take a CEO years to get back money he has tied up in a business.

By selling part of an organization to a private equity firm, a CEO can take some chips off the table and free up some cash, which can be used to diversify one’s investment holdings. The smart move here is to invest across different sectors outside the area one’s business operates in, to capture value or create a hedge, as market cycles can have varying effects across different sectors.

Alternatively, you can use the funds for many other purposes, including funding a new venture, paying for a child’s college education or purchasing a different home.

Obtain greater flexibility

Private equity firms can help business owners attain greater flexibility by providing operational support. While many sponsors used to focus on financial engineering to generate results, some have taken a more operational slant since then.

Because private equity firms frequently have experience in the industry where they are investing, they tend to take a more hands-on approach than other types of buyers. By doing so, they can get involved not only in the day to day of the business, but also with top-level strategy, often taking a seat on the board and attending quarterly meetings and regular on-site visits.

While some financial sponsors may use strategies like this, others take a different tack. There are many private equity firms out there, and an even greater number of factors to consider when selling your business. To maximize your chances of finding the best possible path, be sure to conduct the proper due diligence, which includes working with the right advisory professionals to generate more than one offer and secure negotiating leverage.

Learn More About Joining Axial

Request Information

Subscribe to Middle Market Review

Subscribe to Middle Market Review

Subscribe Today

I want to receive:

Thanks for subscribing!