Equity Recap: An Optional Capital Infusion

Private equity funds offer a way to get a capital infusion for your company for a period of time while maintaining a role in its operation and avoiding a sale or a merger.

It's called equity recapitalization, and it typically involves selling a minority or majority stake in your company to a private equity fund.

With an equity recap, you retain part-ownership and remain involved in the daily operations of the company for an average of five years. Following that period of restructuring and growth, the equity fund typically sells its ownership stake. Then, a second deal is arranged with the equity firm that may involve the owner:

• Selling the remaining stake.
• Retaining that stake.
• Buying back the debt from the equity company and regaining full ownership.

Many candidates for equity recap are private business owners looking for personal liquidity or financing to expand their companies. But shareholder regulations may limit a corporate owner's ability to liquidate — or sell — a large portion of personal shares, which keeps the majority of the owner's personal wealth tied up in the company.

With an equity recap, however, the owner is freed up to sell a large stake in the company. An equity recap can offer multiple advantages, including:

1. Diversifying personal wealth.
2. Obtaining an influx of capital for growth.
3. Retaining some ownership.
4. Positioning the company for growth.
5. An opportunity to recognize significant future equity returns.
6. Limiting financial risk, because the owner's net worth is no longer tied exclusively to the financial fluctuations of the company.

Potential Pitfalls

Despite the advantages, however, if you consider an equity recap restructuring, you should proceed carefully with professional help both during the initial share transfer and the subsequent resale. There are two pitfalls in particular that you want to clarify, both regarding ownership:

• If retaining control of the business is crucial, you must make that fact clear early on in the negotiation process. Many equity recap transactions transfer a majority share of the company to the private equity fund.
• If you want to regain ownership of the company by buying back the debt at the end of the restructuring period, an arrangement must be worked out before the initial share transfer. Many equity recap transactions conclude with the company being sold to a third party with both the private equity fund and the owner relinquishing their shares.

Seek Expert Guidance

One of the most important steps when considering an equity recap is to seek expert guidance in the following areas:

• Determining the value of the company.
  
• Finding an intermediary who will explore investment interest in the private equity community.
  
• Performing due diligence when it comes to potential private equity partners.
  
• Clarifying the tax implications of potential debt and equity recap structures.
  
• Structuring the private equity recap transaction.
  
• Establishing a plan for growth following private equity investment.

Bottom line: An equity recap is a complex transaction that takes several months to complete and also has an interim period of several years. Yet many business owners have found it a preferable path to selling their companies outright or merging with other corporate entities.