How Recapitalizing Can Energize and Boost A Business
It can also be expensive and cost you control of your company
In just five years, the mother-daughter team of Beckey Neal and Kim Wigington, turned their hobby of making decorative candles into Wicks ‘n More, a $5 million company. But revenue plateaued in 2005, and at 58, Becky was thinking about retirement. For many business owners, this would be the moment to sell out.
Instead, the Mantachie, Miss.-based company made a deal to recapitalize—getting value for the owners and a badly needed infusion of cash and business smarts to put Wicks ‘n More on an aggressive growth plan. In March 2006, the partners sold a 75 percent stake to FCS Investments, a private equity firm based in Houston, Tex. The selling price is confidential but the deal was for 65 percent in cash at closing, 20 percent in a five-year note to the seller and a 15 percent payout in the form of an earn out after 12 months. Even though they are now minority owners, Neal and Wigington retain day-to-day control, they say.
This is a typical recapitalization scenario, says Mark Hauser, a managing director of FdG Associates, a private equity firm based in New York. The owner says, “Let’s take some chips off the table,” but isn’t ready to retire or sell out or try for an IPO. Usually, he plans to keep working five to seven more years. By bringing in private equity or venture capital, the owner can build a smooth transition to retirement, do some smart estate planning and—if he has the right equity partners—see his business flourish.
| Resources | ||||||||||||||||||||
|
||||||||||||||||||||
Assisted by a business broker, Wigington and Neal identified and interviewed
three equity firms. They wanted the new owners to keep manufacturing in
Mississippi, maintain the staff of 50, continue operating as a family business,
and expand
its markets. The owners’ chief goals, Neal says, were “making sure the shoe fits, that we have the same goals and get along personally, and whether they can be part of our ‘family.’ ”
The chemistry with FCS Investments worked. Sanjay Desair, a managing partner in FCS Investments, says that he was impressed with the management team. The owners were “creative forces in product development and the company wouldn’t have reached that stage without them,” he says.
Desai also saw a chance to go farther than the founders could. “We think we can grow it into a $15 million company in three to five years,” he says.
FCS immediately began streamlining, taking a hand-written inventory system and computerizing it, creating a customer-service database and establishing new financial controls. FCS experts reorganized the sales team, tracked the results of advertising and shifted campaigns from print to online. “Our business is running smoother from one end to another, and the changes instituted are making everyone’s job easier,” Neal says.
Wicks ‘n More sees FCS Investment as its partner. “With FSC around we have someone to help us. We talk to them every day, looking at importing, reaching out to more boutique-type stores,” Wigington says. When the candle company wanted to buy new wax melters, FSC researched the suppliers and within a month identified a company with U.S. certification. “That would have taken us six months,” Wigington says.
| Private Equity vs. Venture Capital? |
| Read this story from n2growth to learn the difference. |
Recapitalizing is not just about business transition, however. It can also make sense for an owner who is carrying excessive debt or is having trouble achieving a desired level of profitability, says Ann Dugan, executive director of the University of Pittsburgh Institute for Entrepreneurial Excellence. She notes that recapitalizing often costs an entrepreneur between $5,000 and $10,000 for banking and legal fees.
However, Dugan says there are also pitfalls in recapitalizing. It isn’t a panacea for debt, for example—it’s more like refinancing a credit card balance. You get momentary relief, “but you still have other people expecting returns.”
Indeed, she points out that venture capital firms expect higher returns than banks and they want to see results sooner. “It’s usually not patient capital,” she says. Recapitalization may, in fact, increase pressure to grow the business.
There are also control issues, Dugan says. Owners who sell more than 51 percent of the business wind up relinquishing decision-making—no matter how friendly the investors seem. Hauser of FdG Associates, which invests in middle-market businesses with revenues of $50 million to $150 million, says that most equity firms don’t want to take control over decision-making. “We will never know the industry as well as the entrepreneur does,” he says. “The owner spent 10 to 30 years in the business, and it’s in his blood.”
As Wiginton and Neal learned, professional investors can bring contacts and business savvy that many entrepreneurs don’t have. One of FdG’s entrepreneurs, for example, had been trying to make a deal with a major supplier for months. After an FdG executive called a connection, the owner’s call was returned that day. When you’re considering a private-equity recapitalization partner, “look for a firm with a strong Rolodex,” says Dugan.
In another instance, FdG Associates acquired a 70 percent stake in Implus Footcare, a $30 million manufacturer of insoles to specialty-footwear markets. FdG created a five-year plan that included extending distribution to grocery and drugstone chains, introducing other shoe-care products and performance socks, and establishing a woman’s line. Between 2000 and 2005, Implus revenue ballooned to $70 million. “We offered Implus more generic business skills,” says Hauser. “We view ourselves as coaches and partners, suggesting ideas, making introductions.”
Another important thing to remember with private-equity recapitalization is that the investors will be looking for an exit strategy, too. “After five years, we’re entitled to liquidity,” Hauser says. “We either sell the company together, take the company public, or take cash out.”
“If the business sells in five years, it will likely be worth more money under FCS’s leadership,” says Neal. “As long as it grows, we’ll be happy.” Meanwhile, recapitalizing has enabled the founders to “continue to grow the company, and not change its personality,” Neal says.
