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The Half Exit (1/3)

This is the first of 3 articles about exiting your business through re-capitalization.

When most founders think of an exit, they think of the giant company swooping in and writing an enormous check to buy all of their shares. However, the more likely exit for a lot of owners is something that looks more like half an exit. It's called a "majority re-capitalization" or "majority re-cap" and there are pros and cons.

First, let's deal with the definition: a majority re-capitalization is where you sell more than half (hence the term "majority") of your shares to an investor and "roll" the rest of your shares into a new entity the acquirer sets up to own your business.

You become a minority shareholder in your former business.

This week, we're publishing an interview with Lloyed Lobo who co-founded Boast, a software application designed to simplify the process of applying for R&D tax credits. After bootstrapping their first few years, Lloyed and his partner sold the majority of the business in 2020 to Radian Capital for €23 million. They got to take most of the money for themselves but had to leave a little bit ("low single-digit millions") in the company to fund their growth. They rolled the rest of their equity (about 40% between them) into a new legal structure Radian Capital set up to own Boast.

These offers are common for smaller businesses because savvy private equity groups see an opportunity: buy a controlling interest in a company using a mixture of equity and debt, increase its value over time, and then sell it for a higher multiple down the road.

Let's use a hypothetical example to simplify the math. Imagine a private equity company that values a business generating €1 million in EBITDA at €5 million (5 x EBITDA). They acquired 60% of the business for €3 million. The €3 million is made up of €1.5 million of their cash and €1.5 million of bank debt.

With the help of the founder, the private equity group has operated the business for seven years and uses their business savvy, connections, and capital to turn the business into a juggernaut churning out €3 million in EBITDA. The business is larger now and attracts the attention of a strategic acquirer who pays 8 times EBITDA for the company because it's larger and the private equity group knows how to negotiate hard.

The ROI for everyone involved is impressive: the private equity group put €1.5 million of their cash to work and ended up with 60% of a business worth €24 million. Their take is €14.4 million -- almost a 10-bagger on their original €1.5 of cash invested. The founder who rolled 40% of her shares also made out like a bandit. Her 40% became worth €9.6 million -- triple what she got in the original transaction.

That's the theory, but the reality of a majority re-capitalization is more nuanced and includes some pros and cons.

Article of Built to Sell / Valuebuilder, September 2023

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