Dividend recapitalization can be an effective pathway to liquidity for a business owner. It can also lead to plenty of headaches if you haven’t thought it all the way through, says Andrew Dickow, managing director at Greenwich Capital Group.
“Many entrepreneurs don’t think about things like what are the debt covenants I am going to have?” Dickow says. “What restrictions are they going to put on my business? What if I lose a major customer and I have a significant amount of debt service? Can I sustain through that?”
Dickow has spent more than a decade advising clients on buy-side and sell-side transactions, as well as recapitalizations. Prior to joining Greenwich Capital Group, he worked for a middle-market investment bank advising privately held businesses.
In this Q&A, Dickow shares his thoughts on dividend recapitalization strategy and how to find the right path to meet your needs.
Why would I consider a dividend recap?
Suppose you are a company on a fast-growth trajectory. You are looking to help fund and redeploy money back into the business. Your income statement might show you are highly profitable, but the exponential growth may make it challenging to manage inventory and keep up on working capital needs. Sometimes a dividend recap is a great way to give yourself a bridge loan in order to sustain growth and reinvest back in the business to drive medium and long-term growth.
If you’ve been running a business for a long time and you want to maintain ownership, but the lion’s share of your net worth is tied up in the business, there is a lot of value that can be created by being able to extrapolate some of that while maintaining 100 percent equity.
You can allocate that liquidity in a different way, whether it’s a different industry, in an interest-bearing account or alternative investments. If you think about a 401(k) investment or anyone’s allocation in the stock market, you don’t want to have all your money in one stock. There’s a lot of value in being able to extract value into private markets via dividend recap.
What other options are there?
Another option is a majority recap. You’re talking about selling some equity in your business to a third party. It could be a strategic company in your space or a financial investor such as a family office, a private equity firm or a venture capital firm. In these scenarios, you’re recapitalizing your business through the sale of your equity.
Let’s say you want to sell 70 percent of your business to a private equity firm and your business is worth $100 million. You can have a liquidity event, but you no longer own 100 percent of your business. There is a long list of pros to that. You take money off the table and there is no risk or downside. You get money in your pocket today. The downside is if your business continues to outperform over the next five years, you’ve given away 70 percent of the equity and that value is no longer yours.
On the positive side, these private equity firms are typically bringing in additional management and giving you access to resources and connections to help you get new customers. They are helping you on the financial engineering side and they may have back office support they can provide. If they are able to grow your business two to five times faster than you could have on your own, that 30 percent you retain could be worth more than the 70 percent you sold initially.
How can an investment adviser help you find the right option?
When you’re working with a middle market investment bank or anybody who has experience in working through a dividend recap, they model it out for you. They are structuring it with you and doing sensitivity analysis to ensure you are in a good place and you’re not getting too aggressive. Maybe you think you want to take out $20 million from your business. But after doing some sensitivity analysis and understanding volatility, you might be better positioned to take out something more or something less than that. A good place to get started is an adviser who has done it before and can walk you through the process.
Also, it’s absolutely critical to understand the objectives of your shareholders. Once you understand what their objectives are, you can structure a process and a deal that maximizes the outcome while trying to minimize risk as much as you can.
What’s a common mistake to avoid?
Don’t try to go it alone. It’s not dissimilar to if you’re looking to do a sale of your business. You’re essentially working on a deal with a lender. You want to create a competitive process which gives your company the best terms. One of the biggest mistakes people make is they have an existing banking relationship and the bank says, ‘Yeah, we can do this for you.’ But they are not running a competitive process that gets you the best terms.
