Refinancing Alternatives

June 13, 2007
Owners must be proactive, rather than responsive, to optimize the terms of a recapitalization.

Automation entrepreneurs find meaning, pride and enjoyment in owning, controlling and growing their businesses, but most are driven also by a desire for substantial wealth. Eventually, they realize that too much net worth is concentrated in a single, illiquid asset. A recapitalization, or a distribution of cash to shareholders through a refinancing, is an appealing alternative for owners seeking risk diversification and increased liquidity, while retaining the benefits of ownership. It can provide protection against the disaster scenario in which the value of the business is severely impaired along with the owner’s net worth.

A recapitalization can be tailored to meet specific shareholder objectives, such as receiving some of the company’s value in cash, keeping a meaningful equity position and operating autonomy, providing an orderly transition to the next generation of management, enjoying the tax benefits of the recapitalized entity, and tapping into the resources and experience of an equity partner. Unlike a strategic sale, a recapitalization permits a sharing of the risks and upside in the company’s future value and avoids disclosure of sensitive and confidential information to competitors. Structures can range from a full to partial sale of shares, achieving a mix that satisfies the liquidity desires of a diverse shareholder group.

The critical variables in a recapitalization are valuation, the amount and structure of the capital raised, and the use of proceeds. In conjunction with providing shareholder liquidity, additional capital can be infused to fund growth and initiatives to which current shareholders may have been hesitant to commit. Debt financing alone can fund a recapitalization, but this often requires personal guarantees.

Most recapitalizations are led by financial buyers or private equity (PE) firms, which invest funds of privately raised capital. A PE firm is highly motivated to support a company’s management in pursuit of maximizing value in its funds. Some PE firms have extensive contacts and broad industry experience across many similar companies and can provide the perspective to identify strategic opportunities. For example, after being acquired by Audax Group in a recapitalization in 2004, Dynisco, a developer of analytical instrumentation and sensing technologies to the plastic and rubber industries, closed on several strategic transactions, including acquisition of Viatron Corp. and Alpha Technologies U.S. Subsequently, Audax Group exited its investment in Dynisco through sale of the company to Roper Industries in 2006.

Private equity’s role

PE firms prefer that those important to the business retain a meaningful amount of equity to demonstrate commitment and keep interests aligned as equity partners. However, most confine their involvement to oversight, leaving daily operational decisions to management. Because it is expensive and time consuming to identify and partner with a company, a PE firm generally is not looking for a near-term sell but would prefer its investment to generate a high return over a longer period. Usually, the PE firm and company management decide together on the ideal ways to maximize shareholder value, as their interests are closely aligned after a recapitalization.

Good PE firms value their reputations, and success is short-lived if they are known to treat owners and management unfairly; nevertheless, a PE firm’s return on investment is dependent on its price of entry. Thus, owners must be proactive, rather than responsive, to optimize the terms of a recapitalization. Because each PE firm has a unique approach, different investment criteria, and specific areas and industries of focus and expertise, it is best to qualify and negotiate with several PE firms after a confidential process involving only those firms suitable for the opportunity. Once terms have been negotiated, qualitative attributes can determine the final selection.

Charles R. Carson, [email protected], is a managing director of Cronus Partners LLC (, an investment banking firm specializing in automation technology.

Nothing contained in this article is to be considered the rendering of financial, investment or professional advice for specific circumstances. Readers are responsible for obtaining such advice from professional advisors and are encouraged to do so.

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