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What is a recapitalization (recap)?

In the lower middle and middle market, equity groups prefer to structure the purchase of a company as a recapitalization, or recap.  This is most common when a company is large enough to be an equity group’s platform and the owner is willing to stay with the company as a significant shareholder after the sale.  Please keep in mind deals can be structured in many ways, but below example is illustrative.

  1. Let's say a company is doing 25M in Ebitda (Earnings before interest, taxes, depreciation, and amortization), and the total enterprise value (TEV) of the company is determined to be 100M.  The owner and investor agree to this number.
  2. The owner and investor also agree the company can support 50M of leverage.  (The owner is no longer responsible or liable for the leverage on the company since the ownership is changing hands.  But of course the equity group and owner have to agree to the amount that would work.)
  3. Combining 50M of equity and 50M of leverage, the owner is paid 100M for his company.
  4. The owner and investor agree the owner will “rollover” 10M of his proceeds to purchase equity in the combined company, or Newco.
  5. The owner invests pari passu (or, on par) with the equity group.  In other words, the owner is able to take advantage of the 50M leverage as well. 
  6. The total equity in the company is now 50M (40M from the equity group and 10M from the owner), and therefore the equity split is 20% to the original owner and 80% to the equity group.  As of this writing, this investment was tax deferred.
  7. Now the original owner and the investor have invested equity equal to the desired proportion 80/20.
  8. The owner takes home 90M and pays only 10M for 20% of his company.
  9. After 5 years, with the help of the equity group supporting the owner's vision, the company has grown to a value of 200M.  The company decides to sell for this price.
  10. The owner cashes out his remaining 20% for 40M, bringing his total proceeds to 130M.  (This example assumes the entirety of the original debt to acquire the business has been serviced.)

This is just a simplified example, but hopefully this will provide a helpful outline to any owners considering a recap.  If you have further questions on how a recap might affect you, please feel free to contact us.
 

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