Financing a building service contracting company can be tricky. There are a variety of factors to consider, including figuring out which financing options allow for the best combination of cash liquidity, capital for growth and favorable tax treatment, while allowing managers the amount of ownership they desire. The best option for building service contractors may be recapitalization.

Recapitalization is the partial sale of a successful company to a financial partner. In addition to receiving a significant portion of the company’s value in cash at closing, the selling BSC may retain substantial minority equity ownership together with continued responsibility for running the company. With assistance from the financing partner, the BSC can continue to expand his or her business.

For example, assume that a contract cleaning firm is worth $40 million. The contractor wants to retain a minority ownership going forward and is comfortable running the company with $20 million in debt. A financial partner may invest $12 million of equity and arrange $20 million of non-recourse financing through an institutional lender. Using the benefit of leverage, the BSC would receive $32 million in cash (80 percent of the total company value) while retaining a tax-free 40 percent ownership position worth $8 million.

The $32 million could be shared proportionally among all current shareholders. Alternatively, some owners could cash out entirely, while others could receive a mix of cash and continuing ownership.

An outright sale, however, would result in the owner receiving the full $40 million but no continuing ownership, and the company still may need added financing for the new owners to expand operations. Thus, the company would have changed hands but may not have moved forward in its market.

In a recapitalization procedure, a financial partner may be an individual or an institution. Most often such moves involve institutions that are in the business of investing in successful, privately held businesses. These financial partners believe there are many small-to-medium sized companies that can achieve important strategic goals partly as a result of a partnership with an experienced equity firm.

The process only works for successful and profitable companies that have proven histories of exemplary cash flow. Qualified candidates also must have strong market positions, proven management teams, and the ability to grow.

The recapitalization option, however, does not work where management desires to cash out and leave the business. It doesn’t work for start-ups or turnarounds, and it doesn’t work unless the business has demonstrated its market advantage and growth potential.

The benefits of recapitalization can include:

Liquidity without liability – These transactions allow a BSC to take his or her chips off of the table without harming the company or overloading it with debt. Additionally, it is common that the financial partner eliminates the contractor’s personal guarantees tied to the company.

Control – While ownership control likely will transfer to the financial partner, day-to-day operating control remains with management. In fact, financial partners are reluctant to get involved in the business, relying instead on incumbent management to lead the business.

Substantial equity for sellers and management – Recapitalization can be ideal for contractors who desire to free up their personal finances, yet still wish to participate in and profit from the future growth of the business. This is achieved as the selling BSC continues to operate the company substantially as he or she has in the past. The financial partner always ensures that the management team is rewarded with incentives for the value they create while managing the company.

Power for growth – Financial partners are most interested in investing if the target company not only has internal growth opportunities but also is poised to identify and lead the process of future acquisitions and consolidation. Successful add-on acquisitions can rapidly and dramatically increase the value of an enterprise. So while the entrepreneur may own a smaller piece of the piece, that pie can grow much larger.

Flexible structures – Investments are tailored to meet the needs of the selling BSC and the operating managers. Additionally, the financial partner is sensitive to the employees and the surrounding community.

Confidentiality – Most financial partnerships are private with no public registration requirements or mandates for public disclosure, even after a transaction is complete.

Fast closing – While most recapitalizations close within 60 to 90 days from the date of initial introduction to the financial partner, it is possible, with focused effort, to close a transaction involving an exceptional opportunity in as little as 45 days.

After a closing, the financial partner works closely with management and the board of directors to provide advice and assistance in areas such as financial funding options, strategic acquisitions and other long-term issues. Post acquisition benefits include help as a sounding board, a partner for growth and a source for finding alternative financing options.

Later, at the appropriate time, the recapitalized company could go public, be sold in a private sale, or undertake another recapitalization, giving the original entrepreneur a second bite at the apple, which could be even bigger than the first.

Allen Stott and Eric Nass are principals at Executive Sounding Board, a Baltimore-based firm specializing in mergers, acquisitions and divestitures in the building services market.




POSTED ON: 8/1/2002