LET IT RAIN: M&A Market Storming Opportunities For Buyers and Sellers
By G. Thomas Doyal & Mike Paparella
Corporate Finance
Universal Advisor, 2005 Issue No. 1
As it relates to selling privately held companies, many owners felt “parched” by the mergers and acquisition drought over the past several years. Valuations had fallen. Earnings for many middle-market companies were soft. Transaction financing was hard to come by. Fewer buyers were active in the market. In turn, scores of middle market company owners were faced with the decision to sell at a lower value or hold on through the down cycle. Regrettably, some owners sold at deflated values or could not weather the economic downturn, subsequently closing their businesses or filing for bankruptcy.
Recent market activity has reflected a return to more normalized value opportunities and the emergence of new exit strategies. Many owners today are looking for opportunities to diversify their net worth, recognize the value they have created within the company, and take some or all of their chips off the table. Options include leveraging the company’s cash flow and assets with bank loans, selling the company to a strategic buyer, or taking dividends by reducing excess cash. For many owners, however, the prospects of re-leveraging or walking away from the company are not appealing.
An alternative strategy, the equity recap, offers privately held company owners a unique prospect for recognizing value. Equity recapitalizations enable the owner to take a significant amount of money out of the business and simultaneously realize several other benefits, including reducing the owner’s overall personal risk; allowing the owner to maintain day-to-day operating control of the business; the opportunity to recognize significant future equity returns; and the ability to offer a piece of the action to key management through option plans, all while positioning the company for growth.
In this type of transaction, a portion (generally a majority share) of the company is essentially sold to a private equity fund, while the owner or management team continues to operate the company on a day-to-day basis. The equity fund invests capital in addition to utilizing various levels of senior and mezzanine debt to “fund” the transaction. Options are provided to management to encourage them to focus on ongoing growth strategies for the company and to participate in the increase in value they have created for the owners. The equity fund typically looks to assist the management team at a board level with various growth strategies over a three-to-seven-year time frame. The company is ultimately re-sold at an appropriate time in the future. Management and owners then face a decision to cash-in or roll over their equity value after the second sale.
The equity recap process starts with the following activities:
• Select an intermediary who possesses the following traits:
- A group you can trust and who you enjoy working with
- Knowledge and experience with equity recaps
- Contacts and understanding of investment goals with the private equity community
- An understanding of the tax and dilution implications of various debt and equity structures
• Complete the advisory team with a law firm containing private equity experience
• Prepare an analysis of the company’s performance, market position, and future outlook for growth
• Identify key management for inclusion in the process
• Quantify and understand the key elements for success in the future; look for these traits in the equity groups you initially approach
The key is finding the right private equity fund. The reality is that the owner and his/her management team will essentially “partner up” with the equity fund, and identifying and selecting the partner is paramount to the ultimate comfort and success any owner will feel. Typically, a company owner will hire an intermediary (i.e., investment banking firm) to establish a value for the company, help position the company with the appropriate fund(s), and ensure confidentiality of the process so as not to alarm customers, employees, or competitors. Once the private equity firm is selected and a value for the company is determined, due diligence is performed, purchase documents are negotiated, and a closing date is set. The typical process takes four to six months to complete.
In the end, the owner will need to weigh the options of adding a partner and realizing significant value today versus holding all of the equity (going it alone) and realizing full value (for better or worse) in the future. In addition, they’ll have to ask what value can be created by working with a group of outside business people who offer numerous new ideas and, finally, what risk can be mitigated to ensure the future viability and success of the company?
Many company owners facing hat decision today are saying, “Let it rain.”
Thinking About an Equity Recap? Consider the Following Issues:
• What is the value of my company today? Five years from now?
• How much of the company am I willing to sell to recognize my personal liquidity and retirement objectives?
• Who will play what roles in the future, and how can I utilize my existing management team to continue the growth of my company?
• What is the role the private equity group will play in my company? Do I need assistance in evaluating alternative growth strategies and implementing tactics to achieve these goals?
• Where will my company be in three to five years, and can the private equity group facilitate additional investment to help me achieve these plans?
• What are my longer-term plans for operating the company? Do I have a capable team to support my exit?
