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April 27, 2020

Diversifying Wealth: The Equity Recapitalization

Navigating the Continuum of Ownership

Key Takeaways:

  • It is wise to take steps to diversify your net worth and create a personal nest egg.
  • It is possible to achieve personal wealth diversification while staying with your company.
  • There are many liquidity options, including non-control investors.
  • The right investor brings a lot of value beyond capital and you can be very selective.

The socio-economic wreckage caused by the COVID-19 crisis is a stark reminder that concentration of wealth in any single area carries significant risk. Normally, owning and controlling a private business would have advantages over passively owning a portfolio of securities. However, Black Swan events like COVID-19 cannot be controlled and, in the worst case, can wreak sudden and severe – sometimes unrecoverable – damage on a business.

Unless a private company owner generates liquidity – cash – either through periodic distributions of earnings or a sale, the equity value on his or her personal balance sheet is intangible. Most business owners understand this but see only a black or white choice – either continue to own the company or sell out entirely.

There are, however, several viable options between these extremes. Business ownership is not simply a “yes or no” question. Instead, it is a continuum that provides opportunities to gain liquidity and diversify from the unlikely or unknowable risks that will come into play. Thanks to the abundance of capital in the market – even now – eating the cake you have is possible. In fact, with the right choices, your cake can become even larger and tastier than you may have thought.

How? A thoughtfully designed recapitalization transaction can generate a targeted level of liquidity for shareholders while also addressing the ongoing ownership and management structure. The “right” amount of liquidity differs from company to company, but monetizing anywhere from 30% to 90% of equity value through a recap is a reasonable goal. Indeed, securing an appropriate amount of debt as well as investment capital from a compatible equity source can provide more liquidity for shareholders in the near term than periodic distributions or employee contributions to a stock purchase plan.

A recapitalization can achieve multiple objectives, including:

  • Diversifying personal wealth
  • Buying out inactive shareholders
  • Adjusting ownership among family members
  • Allowing equity participation for key management
  • Securing new growth capital
  • Attracting an experienced partner to accelerate growth

The key to deriving the most value – both financial and non-financial – is to identify the best partner. An equity recapitalization, whether involving a non-control or majority investment, is an opportunity to introduce a partner who brings more than just money to the table. Not all private equity investors are alike and, given the large number of firms, business owner can be highly selective.

What makes a good investor? A successful track record with similar business models, access to growth capital, industry connections to speed expansion, expert guidance at the board level are some of the factors. The right investor can help you improve your business, build substantial equity value and enjoy continued day-to-day control. And, by the way, you will have put enough money to the side for personal estate planning and a more secure future.

For more insights from the series, The Path to Private Company Liquidity: A practical guide to M&A for business owners, click here.