Recapitalization – An Underutilized Option for Owners

By: Shane Slominski, Partner at Tonka Bay Equity Partners

When thinking about succession planning, most business owners think they only have two options – they can either sell their business outright or continue to own and manage the business.  There’s a third option that isn’t widely known but can be a great solution too: a recapitalization or a “recap” with a financial partner.  A recap involves selling a majority interest in the business to a private equity firm, while and retaining an ownership stake in the company going forward.  In a recap, owners often sell 70-80% of the business and retain 20-30% ownership.   For many owners, this solution provides the best of both worlds.

When do recaps make sense?

Recaps can be a great alternative to selling 100% of the business, and may be the preferred choice in several situations:

  • The owner wishes to stay connected to the business.  For many owners, the business is a culmination of a life of work, and a cold-turkey separation can be a white-knuckle emotional experience.
  • The owner isn’t ready to step away from being involved in the business.
  • The timing of the sale doesn’t feel quite right because the owner feels that there is still untapped potential in the business, and they may be selling too soon.
  •  There aren’t successors ready to take over the business.
  • The rate of investment needed to continue to fuel the company’s growth is more than the owner wishes to make.

Benefits of a recapitalization:

Living through multiple cycles, including the 2020 pandemic, has caused many business owners to accelerate their timeline to pursue a liquidity event.

A recapitalization with an investment firm can provide an owner the best of both worlds.  By selling 70-80% of the business, they obtain liquidity for the value they’ve created in the business.  This gives them the opportunity to diversify their net worth in other investments, pay off the mortgage on their cabin, and set aside funds for future college expenses for children or grandchildren.  They can continue to be the CEO or play a role they desire over the next several years to stay connected to the business.  And retaining a meaningful ownership stake provides the opportunity to share in future value creation.  This can be rewarding financially and usually has a defined time period, since an investment firm will desire an exit in a certain number of years, and the owner can sell their stake at the same time.

A new partner can also provide resources and capital to accelerate growth opportunities.  This includes investments the owner may not have the appetite to make, such as additions to the team, sales expansion strategies, and add-on acquisitions.  These investments can generate tremendous growth, which perpetuates their business and the second sale can provide another significant liquidity event for the owner in 5-7 years.

While not widely talked about, a recapitalization can be a great solution for business owners and is an opportunity to have their cake and eat it too.

About the author: Shane Slominski is a Partner at Tonka Bay Equity Partners, a Minneapolis, MN-based private equity firm that acquires and invests in lower middle-market businesses.  Tonka Bay partners with business owners to realize liquidity events and works closely with management teams to execute growth strategies and build bigger, better businesses.  Contact Shane at sslominski@tonkabayequity.com and learn more about Tonka Bay at tonkabayequity.com