Who this suits
A leveraged recapitalization suits an owner with a profitable, stable company and little existing debt, who wants to diversify the family's wealth or fund a personal goal, without bringing in a partner or selling. It can also be a step on the way to a sale in a few years, or a way to fund a buyout of a partner or family member.
It suits less well if profits are cyclical or falling, if the company needs its cash for investment, or if you are uncomfortable with debt on the balance sheet, and any personal guarantee lenders may ask for.
How it works
- Lenders assess the company's cash flow: stability of EBITDA, capital spending needs, customer concentration, and the quality of financial reporting.
- They decide how much to lend, usually expressed as a multiple of EBITDA. For companies not owned by private equity, banks typically lend more conservatively than they would alongside a fund.
- The company borrows, typically from a bank, a private credit fund, or a mix including a subordinated (mezzanine) lender.
- The proceeds are paid to the owner as a dividend or distribution.
- The company repays the loan over five to seven years from its profits, subject to financial covenants such as a maximum ratio of debt to EBITDA.
A worked example
Our illustrative company has $4.0 million of EBITDA, no debt and steady results. It borrows $8 million, twice EBITDA, repayable over six years, and pays it to the owner. Assuming an illustrative 8% interest rate:
| Before | After the recapitalization | |
|---|---|---|
| Cash to the owner | none | $8.0m now |
| Ownership | 100% | 100% |
| Debt | none | $8.0m |
| Annual interest (at 8%) | none | about $0.6m |
| Annual loan repayment | none | about $1.3m |
| Cash left after debt service, capital spending and tax | most of EBITDA | roughly halved |
| Equity value if sold today for $24m | $24.0m | $16.0m |
The owner takes $8 million out now and keeps control. If the company is sold three years later, after about $4 million of the loan has been repaid, the owner receives the sale price less the remaining $4 million of debt, so most of what was borrowed has in effect been earned back by the business. If profits fall, however, the debt still has to be serviced, and the lenders' covenants may restrict dividends, investment or acquisitions. Figures are illustrative and before tax.
Wondering how much cash your company could safely raise without selling a share? Let's work through it.
Book a confidential callCosts and risks
- Interest and fees: arrangement fees, legal costs and interest, all paid by the company.
- Less room for error: a downturn, the loss of a large customer or a big capital project can strain a leveraged company quickly.
- Covenants: limits on debt relative to EBITDA, minimum cash-flow coverage, restrictions on further dividends and asset sales.
- Personal guarantees: lenders to owner-run companies sometimes ask the owner to guarantee the loan personally, which defeats part of the purpose. Negotiate hard against it.
- Future sale: buyers pay for the business free of debt, so outstanding debt is deducted from your proceeds.
Comparing it with selling a stake
| Leveraged recapitalization | Minority investment | |
|---|---|---|
| Ownership kept | 100% | 60-80% |
| Cost | Interest and repayment, whatever happens | A share of future value |
| Risk in a downturn | Stays with the company and you | Shared with the investor |
| Outside say in decisions | Lenders' covenants only | Board seat and consent rights |
| Typical cash to owner | Limited by what the company can safely borrow | Limited by the valuation and stake sold |
Tax points to raise with your advisor
This is not tax advice. Questions for your tax advisor:
- S corporations and LLCs: distributions are generally not taxed to the extent of your basis in the company; amounts above it may be taxed as capital gain. Borrowing at company level and distributing can be efficient, but the details matter.
- C corporations: dividends are generally taxed at qualified dividend rates (up to 23.8% federally including the net investment income tax), and the company cannot deduct them.
- Interest deductibility for the company is subject to limits based on its earnings.
How ExitBuy helps
We help you decide how much debt the company can carry safely, approach a range of banks, private credit funds and mezzanine lenders, and negotiate the interest, covenants and guarantees, so the comparison with a minority sale or full sale is made on real terms rather than assumptions.
Frequently asked questions
How much can my company borrow?
It depends on the stability of profits, capital needs and the lender. For companies without a private equity owner, lenders are usually more conservative than in a fund-backed buyout.
Do I have to give a personal guarantee?
Sometimes lenders ask. It is negotiable, and stronger companies can often avoid it.
Can I still sell later?
Yes. The debt is repaid from the sale proceeds at closing.
Is a dividend recapitalization risky?
It adds risk to the company. Keeping borrowing well within what the company can repay in a weaker year is the way to manage it.
Why not just pay myself bigger distributions each year?
You can, but a recapitalization brings forward years of distributions as a lump sum now, at the cost of interest.
Mauro Terrinoni, CFA, founder of ExitBuy Co. 25 years in investment banking and private equity, including at JP Morgan, Citigroup and Fortress Investment Group, and has bought, run and sold a company as its owner.
General information only, not investment, legal or tax advice. Figures are illustrative. Tax rules change; confirm current law with your own advisors.