Beyond The Full Sale: Recapitalization For Founders As An Exit Option

Recapitalization for founders as an exit option is a strategic move that creates a balance between selling and retaining ownership. A well-structured recapitalization deal allows you to unlock some of the value you have built with your company.

Founders are increasingly realizing that selling a company they have worked so hard to build is not always an option. Especially when they have the expertise and skills to continue scaling it and taking it far beyond its current stature.

At the same time, it’s understandable that they want to de-risk their wealth when all their liquidity is locked. The prospect of an eventual retirement does play a crucial role in making this decision. However, harvesting value and diversifying their investment is also a consideration.

Recapitalization enables you to retain a controlling stake in the company and continue running it to realize your vision. Moreover, you’ll leverage the possibility of selling the remaining stake at a much higher price as the company continues growing. Let’s dive in to understand more.

Understanding What Recapitalization as an Exit Option is

When founders exit a company, it is typically through a strategic merger or acquisition (M&A) deal. Alternatively, they may take the company public by issuing an Initial Public Offering (IPO). Entering into a leveraged buyout where the management purchases the company is also an option.

Recapitalization is a middle ground that allows you to retain a portion of the equity while staying on as CEO. You’ll continue running and scaling the company as before, but gain some liquidity to invest in other opportunities. And that includes diverting the funds to build new ventures.

By now, the company is stable with a varied product portfolio and has an excellent management team. It has consistent cash flows, robust financials, and adequate credibility to raise funding or attract investors. As the founder, you’re aware that the company has the potential for rich returns.

Selling a 100% stake means that you’ll lose out on the future profits the company can earn. At the same time, you want to divest some of the liquidity. Recapitalization for founders as an exit strategy is a great solution. You’ll reach out to investors who can bring a capital infusion.

These investors can also bring organizational and operational expertise that the company can benefit from. Private equity firms typically invest in recapitalization deals.

Their investment horizon ranges from five to seven years, within which they intend to scale the company exponentially. At the end of this time, PEs divest their holdings for substantial returns.

Recapitalization can be of two types–majority and minority. A majority recapitalization involves bringing in investors who will own more than a 50% stake in the company. On the other hand, a minority recapitalization ensures the founder retains more than 50% of the equity.

How Recapitalization for Founders as an Exit Option Works

When you opt for recapitalization as an exit option, you’ll choose either of two pathways. Your role in the company changes per the terms and conditions of the deal. Alternatively, the company’s cap structure changes when investors purchase the pre-determined equity stake. Here’s an example:

1. Your company is valued at $250M, and you accept an offer to sell a 60% stake in it. The PE investors invest capital worth $150M into the company, which goes to the shareholders. You’ll retain the remaining 40% or a minority stake in the company.
2. As the founder, you’ll continue managing the operations. Once you achieve the agreed-upon milestones and the company reaches the desired performance metrics, you receive an earnout. Let’s say the earnout is $50M.
3. A few years later, the company is now worth $350M and is sold in a second transaction. As the holder of a 40% stake, you’ll receive $140M.

This strategy not only helped you lower the risk, but you also earned a share in the profits. Thanks to the hard work and dedicated efforts of your partners, the company reached a much higher valuation. All the parties participating in the deal benefited from significant returns.

Of course, successful recapitalization hinges on multiple factors, and choosing the right partners is at the forefront. You’ll ensure that your goals and objectives from the deal align, and that the terms and conditions are competitive.

How Recapitalization Proceeds

Hiring an M&A Professional

If you’ve been considering recapitalization, you’ll start by reaching out to an expert mergers and acquisitions (M&A) professional. You’ll look for extensive experience and a track record with such deals. Also, ensure that they have a widespread network and connections within the industry.

M&A advisors bring in-depth knowledge about the sector and market conditions that can prove to be invaluable. They’ll also assist you by connecting you with private equity (PE) firms looking for promising companies to invest in. Here’s where their network comes into play.

Not only are advisors trained in creating optimum deal frameworks, but they’ll also explore all the available options. You can rely on their expertise to guide you through the structure that is most beneficial for the company.

The M&A professionals will align a selection of PE firms that have the necessary resources to back your company. Most importantly, they’ll connect you with potential partners who share your vision for the future.

You need collaborators who are interested in the company’s long-term success and are willing to contribute more than just capital. They should be committed to enhancing the company’s performance by providing all the necessary resources.

What Private Equity Firms are Looking For

As a rule, PE firms are not interested in purchasing a 100% stake in a company. Their objective is to retain the original founder and management in their respective positions to continue running its operations.

Further, their investment horizon is an average of five years, within which they expect accelerated growth ranging from 2x to 3x. The investors intend to sell the company at the end of this period for a substantial profit.

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Timeline for Concluding the Deal

Opting for recapitalization for founders as an exit option typically involves a timeline ranging from four to six months. This period includes the time taken for prepping the company’s financials and other documents, marketing the company, and selecting investors.

Creating the recapitalization frameworks and finalizing the deal is also a part of the process. Do keep in mind that since founders are minority shareholders, they don’t have a say in the company’s sale. However, a good working relationship between the partners can ensure goal alignment.

Speeding Up the Recapitalization Process

Choosing recapitalization for founders as an exit option is much like any other exit strategy when prepping the company. You’ll organize and update the financial statements and all other relevant documentation and prepare it for due diligence.

Why Partner with Private Equity Firms for Recapitalization

As your company scales quickly, you can reasonably anticipate that it will need specialized talent and additional skills. A founder cannot be adept at managing all the aspects of the business. This is why they should be prepared to hire professionals to handle the different departments.

Once the company reaches a valuation of $10M and above, you’ll need this professional support and their expertise. At times, appointing a new CEO can also be crucial for management efficiency and a fresh perspective. A change in leadership can benefit the company in multiple ways.

At this time, planning a complete or partial exit is a strategic move, and taking on a reduced role is advisable. Ensuring that the company retains its competitive edge can also be one of the drivers for a recapitalization.

Partnering with a private equity (PE) firm is an excellent pathway for ensuring an accelerated growth trajectory.

How PE Partnerships Accelerate Growth

• PE firms work with an extensive network of talented professionals with diverse skill sets. They can assist you in hiring the right team to take the company forward. Setting up new departments to handle company operations and staffing them with new roles is part of their strategies.
• PE firms can contribute operational expertise and assist in optimizing areas that need improvement.
• The right PE partners can help you build strategic partnerships with entities in supplier and distributor networks. As a result, you can streamline inventory availability and improve sales efficiency.
• PE firms have a broad portfolio of companies they have partnered with in various sectors. You can leverage the experience they gain during their operations to fill the knowledge gaps that you may have.
• PE firms will assist you by making substantial changes in the company’s framework to ensure growth. For instance, revamping the business and financial models and leveraging more efficient benchmarks and metrics to evaluate its performance.

Why Recapitalization is a Strategic Approach

Recapitalization for founders as an exit option has multiple benefits for all the stakeholders, not just for the company owners.

For Founders

Founders wanting to remain involved with the company they built is understandable. Even if that means transitioning to a less influential or passive role, they are open to the possibility. Delegating leadership and the company’s operations to more capable hands is advisable.

This strategy gives founders the flexibility to move on to other projects and remain as advisors on the board. Further, if you anticipate the company is likely to reach much higher valuations, it makes sense to retain equity. You can liquidate this stake for higher returns when the company is sold.

On the flip side, founders may also choose recapitalization in an economic downturn even if the valuation is low. The company gets a cash infusion to keep it afloat and navigate the slowdown. On their part, founders can de-risk their stake but retain equity to capitalize when markets improve.

For Shareholders

When PE firms pay cash for a stake in the company, shareholders receive the money. They can liquidate their stake and profit from their long-term holding and faith in the company. A higher company valuation yields more profits, which is a reward for staying vested.

Current shareholders include friends, family, and colleagues who have invested in the pre-seed round. Other investors include angels, VCs, banks, and any other capital sources you may have tapped.

For the Company

A fresh infusion of cash can spur the company’s growth so it can achieve its next milestones. Any expansion efforts need a lot more than just capital. They also need the exceptional expertise and advanced growth strategies that collaborating with PE firms can provide.

At times, companies reach a stage where the existing team and its efforts are no longer adequate to propel growth. Recapitalization can help overcome the stagnation and launch it forward with new value inflection points.

The key here is to select partners who understand your mission and vision for the company. They should indicate an interest in helping you achieve your goals.

Navigating economic downturns and fluctuating market conditions are other areas where private equity investors can help. If the company is facing challenges that are impacting the entire industry, investors may step in to cover the shortfalls.

As long as the company has demonstrated historically great performance, they may be interested in sustaining it through the slump. The cash infusion they provide can pay off debts and reduce the financial burden. The money can also help keep the company afloat until conditions improve.

Ensuring the company remains stable and secures its assets gives it a better chance of success. PE firms make that happen by instituting a success plan to handle unexpected situations.

The Takeaway!

Recapitalization for founders as an exit option can prove to be beneficial for all the stakeholders. And that includes the company’s founders, existing shareholders, and most importantly, the company. You can de-risk your investment, but also ensure profits from its future success.

A fresh capital injection and expert guidance spur exceptional growth, taking the company to new heights. As long as you select the right partners, you’ll ensure significant benefits, exceptional company performance, and long-term success.

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