The formulas, tricks and trade secrets of Private Equity

Leveraged Recapitalization Exit Strategy

Sample Chapter

A recapitalisation (recap) is one of many potential ways that a private equity firm can exit an investment (see this post for an overview of exit strategies). It involves a business borrowing money to fund a repurchase of equity from an investor that wants to exit. A recap is usually marketed as a way for an owner/manager to continue running the business if they do not want to sell when the private equity firm does.

There are a few points I’d like to make about recaps:

  1. A recap is unlikely if the firm owns all/most of the business. If the investor owns most of the business, then it is unlikely the bank will lend enough to buy the entire equity stake. The only way this would work would be if the expected sale multiple was the same or lower than the lending multiple. That is, if the bank would lend 3x earnings and the investor only wanted 3x earnings for their stake. But, this would be highly unlikely.
  2. A recap will rarely involve the natural buyer. The buyer in a recap is the business itself and one would imagine that the most natural buyer of a business wouldn’t be the business itself. The natural buyer is the buyer that can rationally pay the most for the business due to synergies, opportunities and other areas of value uplift. This is why sellers most commonly seek to sell to the most natural buyer, because in theory they can pay more.
  3. A recap represents increased risks and costs. Even though we’ve learnt that capital structure shouldn’t influence our valuations, in reality, the remaining owners of a recapitalised business will incur increased risks and costs due to increased debt. This can only negatively affect the price a rational buyer is able to pay. The counter argument to this is that gearing also represents the potential for increased value creation, so in some ways it offsets risk, but in reality the risk is still there.

Overall, I’d say that a recap would represent a less than ideal outcome. It may be necessary when a private equity firm must exit, but it would rarely be the ideal plan prior to the initial investment. This is simply for the fact that a recap doesn’t represent the most natural buyer and hence it wouldn’t represent the highest possible price. For this reason, I would say that a recap isn’t a compelling exit strategy and is only a saving grace in unfavourable circumstances.

A leveraged recapitalization (or recap) generally means a change in capital structure. However, in private equity, it mostly refers to exiting an investment by way of replacing the private equity firm’s equity ownership with someone else’s capital, such as a bank’s. A recap is often citied as a way to successfully exit a business.

A private equity firm can only successfully exit through a recap if their equity interest is minor. That’s because a bank will only lend to moderate multiples of say 3 to 4 times earnings. If you own the entire business, then in theory, a bank would only buy you out at 3 to 4 times earnings, which in most cases isn’t a successful exit. But that’s only in theory anyway. In practice, a bank will never lend 100% of capital to a business. As the bank lends more money, the risk increases, and the cost of debt increases to a point where neither the bank nor business would want to continue.

Restructuring a company’s debt and disinterestedness mixture, a lot of about with the aim of authoritative a company’s basic anatomy added stable. Essentially, the action involves the barter of one anatomy of costs for another, such as removing adopted shares from the company’s basic anatomy and replacing them with bonds.

In accumulated finance, a leveraged recapitalisation is a change of the basic anatomy of a company, a barter of disinterestedness for debt

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