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What is a leveraged recapitalization?

December 23, 2015

While having a solid product or service and a strong management team help foster the success of a business, having an efficient balance sheet and access to necessary capital are critical tenets of corporate finance that every business should follow. For many middle market entrepreneurs, however, after making the initial investments to start a business, it might be difficult to free up capital in order to pursue growth initiatives. Pursuing a recapitalization is a useful process for many owners and shareholders to gain access to the critical funds necessary for success.

The recapitalization process runs the gamut of available possibilities, from no change in the owner’s daily operational involvement to bringing in other operating partners. On one end, shareholders can obtain incremental debt and utilize that capital for sustainable growth and acquisitions that can generate greater profits and increased market share. On the other end, this process can eventually lead to a full sale of the enterprise.

But when is the right time for a recapitalization? Since so much of the success may revolve around timing, availability of capital and industry conditions, it is wise for owners and shareholders to discuss a recapitalization opportunity with advisors who are well versed in corporate finance and understand their business objectives.

Internal factors
A company will likely need a low debt to equity ratio to qualify for a recapitalization. A recently established business will not be a good candidate for a recapitalization as there will not be enough data to demonstrate the business’s track record of success. Without this information, it will be very difficult to determine a premium valuation or demonstrate accurate sales projections.

In addition, a recapitalization is not a process that a company can accomplish in a few weeks or even a few months. Typically, all shareholders will need to agree on the plan first. Once in agreement, the management team will need to organize all account statements and prepare any additional financial records that may be requested. The company will also need a valuation, which should be performed by a qualified valuation advisory firm.

External Factors
In today’s capital market, there are a variety of potential lending sources who are actively seeking new investment opportunities. Business owners often assume the first place to borrow money is from their bank; however, given the amount of non-traditional banks active in the market, it would be worthwhile to evaluate the terms that other lenders could potentially put forth.

“All avenues of recapitalizing must be explored before anyone comes to a final conclusion.”

Additionally, it is important to consider whether or not the lending source fits the company culture and, of course, the cost of the new capital. While seeking out the ideal lender pool could be extremely challenging for a management team, many companies elect to enlist the services of corporate finance experts who will identify the possible capital sources and negotiate on the company’s behalf.

As the Charlotte Business Journal noted, recapitalizing represents a critical crossroad for companies, and all avenues must be explored before reaching a final conclusion. Owners seeking to recapitalize must ensure the business is sufficiently established and all the parties involved in the decision are on the same page. At the same time, other market forces must be met as well, such as finding the right lender(s). With the right advisors, recapitalizing can provide a much-needed capital infusion to help businesses reach the next milestone.

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