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Recapitalization: Top Reason for Sale of Small Businesses in the Lower Middle Market

Posted by Jane Johnson on Tue, Jan, 03, 2017 @ 11:39 AM

negotiatation-1718868_960_720-656532-edited.pngAccording to the quarterly Market Pulse Report published by the International Business Brokers Association (IBBA), M&A Source, and the Pepperdine Private Capital Markets Project, for the first time in nearly three years, recapitalization has replaced burnout as one of the top reasons that businesses valued at $5-50 million go to market.

While retirement, burnout, and family issues continue to be some of the top drivers for sales under the $5 million mark, Scott Bushkie, Certified Business Intermediary, President of Cornerstone Business Services, Inc. and IBBA Chair, suggests that “The uptick in recapitalization activity could be an indicator that Lower Middle Market business owners are becoming savvier about their exit planning options and planning more in advance.” The Market Pulse Report found a substantial increase in private equity activity in the $5 million to $50 million category in Q3 2016 (50% of buyers) compared to Q2 2016 (39% of buyers).

Understanding Recapitalization

Recapitalization is when a business owner sells a piece of his or company – either a minority interest (less than 50%) or a majority interest – to a private equity investor or firm. These financial buyers typically invest in companies with an existing management team in place, employees, and an overhead structure in order to run the business. The buyers may even want the owner to stay on for a period of time to run the business, partnering to continue to grow the business, with reduced risk for the owner. It’s beneficial for the owner because he or she no longer has all of his or her eggs in one basket. And by maintaining some ownership in the business, the owner may be able to get the proverbial “second bite of the apple” if the business is sold again in the future.

“More business owners are finding that recapitalization minimizes the risks and stresses of operating a business,” said Craig Everett, PhD, assistant professor of finance and director of the Pepperdine Private Capital Markets Project. “Sharing financial responsibility with a private equity firm is a smart move for business owners who need strategic support or a cash infusion. When owners become ready to sell and retire, recapitalization can make their companies more attractive to buyers.”

What Investors Care About & What Owners Can Do to Increase Their Attractiveness

Interestingly, similar to what we discussed in Would a Private Equity Firm Be Interested in YOUR Business? the survey reports five key weaknesses buyers care about most:

  • Declining profits
  • Declining sales
  • Poor financial reporting
  • Lack of management team
  • Customer concentration

Owners need to identify their weaknesses and fix them during the business transition process in order to achieve their attractiveness to investors. Knowing that private equity investors are looking for future return on investment and growth potential, remember to emphasize this rather than dwelling on past performance. Growth opportunities, reputation and industry leadership are some of the many tangible qualities investors appreciate. Documenting improvements that can be made with new capital helps you to position the company better and can increase value substantially.

In a recent webinar, How to Sell Your Business to an Outsider, we discuss how we helped one of our clients prepare his family business, sell 75% of it to a private equity group, and then sell his 25% holding for a “second bite of the apple.” We cover what owners can do to maximize business value, minimize taxes, find the right buyer and negotiate the best possible deal. We will also discuss other types of buyers, how to avoid the Top Ten Deal Killers, and more. Click Here to View Recorded Webinar.

If you are thinking about selling your business and realize you need to grow the value, you may want to consider a private equity recapitalization. Seek independent and objective advice before making any decisions. There are many possibilities for ownership transition that will enable you to achieve your goals. You want to be sure you consider all of them before taking this big step.

About the Survey

The Q3 2016 survey was completed by 278 business brokers and M&A advisors, representing 38 states. Half of the respondents (51%) had at least 10 years of experience in the industry. Respondents completed 246 transactions this quarter. The Market Pulse Report compares conditions for businesses being sold on Main Street (values of $0-$2MM) to those being sold in the Lower Middle Market (values of $2-$50MM). The Q3 2016 survey was completed between October 3 and October 18 by 278 business brokers and M&A advisors from 38 states.

About Business Transition Academy

Our mission at BTA is to educate owners about the benefits of planning for an eventual transition from their business. Jane Johnson offers business transition advisory services to companies with annual revenues greater than $5 million, and assists smaller businesses to prepare for their own business transition by providing free educational tools and resources. These tools can be found in our Resource Center that offers information, case studies, videos, transition guides, and more.

To learn more about how the Business Transition Academy can help you, please check out our webinar series.

Topics: selling to a private equity firm, selling your business to a private equity firm, recapitalization