“Choices are the hinges of destiny.” – American poet Edwin Markham
Fast-growing, profitable middle market businesses have plenty of choices when it comes to M&A transactions. And the wide range of alternatives can make it difficult to select the best path for your business. So we’ve outlined a few pros and cons for several of the more common alternatives to help you start thinking about it.
Acquisition for Cash by a Larger Business
- Complete liquidity for all your current owners
- Reduced responsibility for the future performance of the business
- Access to more resources and customers
- Loss of control over the future of the enterprise that you have built
- Uncertain career opportunities for your team members within a much larger organization
- Your team will need to assimilate to a new and different (and often more bureaucratic) corporate culture
- Very limited or no participation in future economic upside of the business (except to a small extent in the case of an earnout)
This transaction comes in two flavors – high leverage and low/no leverage. What constitutes high and low leverage is in the eye of the beholder, but we typically aim for total debt to EBITDA of less than or equal to 2x at the time of our investment.
- Substantial liquidity for some or all of your owners
- Diversification of the personal wealth of the entrepreneur, which is often concentrated in a single asset, the business
- Potentially valuable insights from an experienced financial partner whose ownership interest is aligned with yours
- Greater professional growth opportunities for the members of your team than in a complete sale
- “The Orchard” – The term “two bites at the apple” is sometimes used to refer to the fact that a recapitalization offers the founding shareholders a chance to participate in two liquidity events – one at the time of the private equity investment and the second in the transaction by which the private equity firm sells its ownership position. In many of RLH’s companies, the founders’ proceeds from the second bite (even after a majority recapitalization) substantially exceed the size of their first bite, so we prefer to refer to this opportunity as the entire Orchard.
- Relinquishing some aspects of control of the business (although in the RLH model, the incumbent leadership team typically continues to manage the business).
- Giving up some of the future upside of the business.
- The investor will require an exit transaction at some future date, which ensures that another change of control transaction will occur.
High Leverage vs. Low Leverage
More debt may result in greater total proceeds at the time of the recapitalization, but leaves the business going forward with less opportunity and at considerably greater risk. Success and organic growth are more likely when:
- Sufficient capital is available to aggressively pursue initiatives such as developing new service offerings, opening new locations, adding sales resource, and enhancing the talent management organization.
- Management can focus their valuable time and attention on building the business rather than making debt payments and meeting financial covenants.
- New approaches to your market can be thoughtfully tried without fear that an unsuccessful idea will push the company into loan non-compliance or illiquidity.