Every business owner knows that access to cash is the key to successful business and financial management – it’s the fuel that feeds the profit engine. In a world where business interruptions are spawned by non-financial events, such as COVID-19 and civil unrest, short-term solutions such as the Economic Injury Disaster Loans (EIDL) and Paycheck Protection Programs (PPP) lending programs provide some help, but in many cases aren’t sufficient for enterprises to stay true to their operating model.
The Power of Leveraged Recapitalization
A longer-term solution to maintaining critical liquidity is the “leveraged recapitalization, or “leveraged recap.” In this strategy, the business owner changes his business capitalization structure, replacing a portion of owner equity with senior bank debt or subordinated debt, freeing up cash needed to continue operations and adhere to their growth plan. It’s also a strategy for recouping some of the owner investment in the business over time.
Many conservative business owners eschew long term debt, but in circumstances where the company has the opportunity to access necessary resources and does not want to take on an equity partner or, even more drastically, sell the business, a leveraged recap can be a sensible solution.
When to Consider a Leveraged Recap
Leveraged recaps are often used to prepare for a period of growth, since a capitalization structure that leverages debt is more beneficial to a company during growth periods. Other benefits of leveraged recapitalization include:
- Borrowing money to pay off debt older debts can provide net cash savings when interest rates are low.
- Using debt vs. equity to maintain operations can provide a tax shield.
- Leveraged recapitalizations provide incentives for management to be more disciplined and improve operational efficiency, to meet debt service payments.
- When a company keeps its’ leverage ratio within the range of that businesses’ particular industry norms, a leveraged recap will not disadvantage the owner when time comes to sell the business.
Finding the Right Opportunity
For an otherwise reasonably capitalized business owner seeking another layer of growth capital, and perhaps a safety cushion of cash for a rainy day, this maneuver can make a lot of sense. And as every business owner knows, borrowing money is much easier when times are good than when sales get lean and interest rates are high.
Leveraged recaps do not fit every business. Companies that already have a high-leverage ratio would not qualify, so business modeling and financial analysis of the company are essential to avoid creating unacceptable risk.
Information Lenders Will Require for a Leveraged Recap
Commercial and subordinated lenders will want to see a thorough rationalization of the use of funds, multi-year projections showing debt service and repayment metrics, and benchmarking of the company against industry norms, prior to, and after, the leveraged recapitalization transaction.
Have a question about whether a leveraged recap is the right solution for your business, or want additional information? Contact Barnes Dennig – our experts are here to help.