This is our favorite structure of transaction and it allows the seller to sell their company twice, and quite frankly many more times than that if they wish. We call the structure a “Majority Recap” and it allows the seller to take 2 bites at the apple as we say. Here is how the structure works followed by an example of a company worth $40 mm and how the mathematics work:
- A seller sells less than 100% of stock in his/her company but more than 50%.
- The sellers receives MORE than the pro rata value of stock sold in cash or similar value.
- The seller partners with the buyer, typically a private equity group, to continue to grow the company. The capital used for growth is from the buyer. The seller’s proceeds are safe in the bank (the seller has effectively taken chips off the table and protected that wealth). Typically the seller takes on a different, higher level role than he/she was prior to the transaction as the goal of the seller was also to exit from the daily grind. A seller may move into a role of strategic planning and growth as well as focus on possible other acquisitions to facilitate growth.
- After a period of time, typically between 3 and 7 years, as the goal was to grow the selling company fairly aggressively, we assume the company is now materially larger than it was when originally sold. The seller now sells all or a portion of the stock he/she retained from the original sale. The proceeds to the seller from this sale are typically the same or larger than those realized from the first sale.
- The seller can continuously retain a portion of stock in the company at the time of a sale and continue to partner with buyers to grow the company and sell additional stock at future dates.
Numeric Example:
- Let’s start with a company that is worth $40 mm. The seller in this example sells 75%. The seller you would think receives $30k for 75% but in fact will receive approximately $35 mm (we can elaborate on the math behind this at a later date).
- The buyer is a PE (private equity) group that will partner with the seller to grow the company. The PE group does not want to get involved in the daily activity of the business. They will contribute the necessary capital, provide ideas based on things that have worked in other of their companies, provide introductions to people and companies they know to facilitate growth, and try to work with their other portfolio companies to facilitate growth.
- The Company is tripled in size in 7 years (example only) as new branches were opened etc. with capital contributed from the investment group. The Company is sold for $120 mm and the seller receives 25% of this value, or $40 mm in this example.
After the two sales of stock in the example above, the seller has walked away with $80 mm from the sale of a company that was originally worth $40 mm.
This type of deal structure is very common and probably takes place with 50% of the transactions we close. It is very good for sellers that don’t want to retire completely from their business, or sellers that have children that can carry the torch after the first sale and reap the benefits of the second sale. From a wealth planning perspective it is a preferred structure because it allows a seller to take chips off the table immediately (from the first sale) while continuing to roll the dice with the stock that remains in the company. The original $40 mm in our example however is safe forever in terms of family wealth. This is very important for many business owners where the majority of their net worth is tied up in the value of their business.
From an operating stand point, buyers really like this type of structure because it minimizes their risk related to an owner leaving the business. In our case the owner, or their children, are remaining in the business and maintaining management team consistency through the transaction. In many cases buyers are even willing to bid higher for companies when this type of structure is in place, again as their management team risk with the seller is effectively eliminated.
When is this the best type of deal structure to pursue:
- When the seller is not ready to walk away completely from the business and is willing to partner with an equity group to grow the business.
- When a seller has children in the business who can remain with the business post first sale and work with the private equity partner to grow the business. The children can cash in on the value of the stock they retain based on the future growth they facilitate. The original entrepreneur, father or mother in this case, or both, take most, if not all of the cash from the original sale.
- When an owner or management team is relatively young and simply wants to take chips off the table via the first sale and get help, or need help, via the capital of an equity group, to continue the growth of the company.
There is very little downside to this type of structure. From a wealth management standpoint, the seller is taking family wealth off the table as they say and locking that value in the bank so it is no longer at risk. If the future unfolds the way the seller plans, then there is a second bite of the apple. If for some reason the future does not unfold as planned, then more often than not the seller likely sold at the right time the first sale. In other words if things have deteriorated to the point where there is no second bite of the apple, then the seller did right by selling at the time he/she did the first time around prior to things and the value of the business deteriorating.
The majority of the transactions we complete are of this structure. Call or email us with any questions on this or any other type of structure.