Private Equity Recapitalization: How It Works

Owners of privately held businesses typically have a large portion of their personal net worth tied up in the companies they have worked hard to build. When considering liquidity and wealth diversification options, however, business owners often ask themselves an over‐simplified question: “Should I sell or not sell?” The answer to this question does not have to be an absolute “yes” or “no” response. By considering a private equity recapitalization, a vast menu of sale and liquidity options become available depending on the business owner’s age, desire to remain involved with the business, vision for the business, and liquidity requirements. Simply put, a partial sale of the business to a private equity buyer (a recapitalization) can accomplish many of the business owner’s stated objectives without selling 100% ‐ achieving some liquidity today, providing a path to additional liquidity on a future sale, and securing a deep‐pocketed partner that is committed to growing the business. Equity recapitalization transactions enable our clients to largely cash out of their investment in the business and capitalize on the enormous amount of sweat equity they have put into their business over the years.

An equity recapitalization represents an alternative to a complete sale of a company. The original owner can continue as a partner and/or manager of the company, while the new partner is a private equity firm that shares the business owner’s culture and vision for the future. Unlike some strategic acquirers who purchase with a view towards eliminating overhead redundancies, private equity firms prefer a more passive or board level involvement and a collaborative relationship with the existing owner and management. As partners, these private equity firms are able to bring strategic opportunities to the company that were not previously available, and can provide strategic management experience in order to assist the company to its next level of growth.

Today, in the United States, there are over 2,000 private equity groups with committed funds. These groups distinguish themselves in a variety of ways, but they all share the common goal of investing in and growing privately held companies. Most private equity groups have clearly defined characteristics they are seeking in businesses: size (revenue and/or EBITDA), industry, geography, and owner/shareholder objectives, among others. Matrix maintains close relationships with hundreds of these groups and has extensive experience in identifying the appropriate private equity buyers to include in an equity recapitalization process, depending on the business owner’s transaction goals.

Characteristics Considered By Private Equity Characteristics of Private Equity Groups That Groups Investing in Businesses Should be Considered by Business Owners  Size (Revenue/EBITDA)  Control vs. Non‐Control Investing  Margins/Profitability  Operationally Focused vs Passive / Silent Capital  Historic Performance  Average Investment Hold Period  Management Team  Prior Industry Experience  Industry  Common vs. Preferred Securities  Geography  Amount of Uninvested Capital Left in Fund  Growth

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Consider the following example of an equity recapitalization to a private equity buyer: Notes & Assumptions

Valuation  The company is recapitalized at a valuation TTM EBITDA $ 5,000,000 of 6.5x EBITDA. Purchase Price EBITDA Multiple 6.50x  Company debt of $4.0 million is retired by Enterprise Value $ 32,500,000 the selling shareholder, resulting in net Less: Funded Debt (4,000,000) proceeds of $28.5 million. Equity Value $ 28,500,000  Any excess cash or other excess liquid assets

would be retained by shareholders. Proceeds to Shareholders  Current owners “roll‐over” $5.0 million tax Equity Value $ 28,500,000 deferred and retain 36% of the equity – Plus: Excess Balance Sheet Cash ‐ Gross Proceeds to Shareholders $ 28,500,000 results in $23.5 million net cash to Less: Reinvestment/Ro ll‐over (5,000,000) shareholders. Net Proceeds to Shareholders $ 23,500,000  Sellers pay transaction expenses and taxes out of net cash proceeds.

Sources & Uses of Funds

Sources x EBITDA

Senior Term Debt $ 12,500,000 2.50 x Subordinated Debt 6,250,000 1.25 x  A senior debt facility equivalent to 2.50x Financial Sponsor Equity 8,750,000 1.75 x EBITDA is arranged. Reinvested Roll‐over Equity 5 ,000,000 1.00 x  Mezzanine debt of 1.25x is arranged. Total Sources $ 32,500,000 6.50 x  Private equity group invests cash of $8.75 million for 64% of the equity. Uses  Current owners “roll‐over” $5.0 million tax Purchase Price $ 32,500,000 deferred and retain 36% of the equity. Total Uses $ 32,500,000

Pro Forma Equity Undiluted Diluted  Management (previously non‐owners) is Financial Sponsor Equity $ 8,750,000 63.64% 57.27% provided with stock options for up to 10%. Reinvested/Roll‐over Equity 5, 000,000 36.36% 32.73% Management Stock Option Plan ‐ 0.00% 10.00% Net Result: Shareholders are able to extract Total Equity $ 13,750,000 100.00% 100.00% 82% of the equity value of the company in cash

while still retaining 36% ownership (versus

18%).

As this scenario illustrates, a business owner can elect to re‐invest some proceeds from the sale back into the business (typically on a tax deferred basis) and maintain a significant ownership stake alongside a new private equity partner. While this outcome in very different than an outright sale to a strategic buyer, it allows a business owner to keep some “skin in the game” and realize significantly more upside when a future sale occurs (generally 3‐5 years later).

Page 2 of 4 The following table summarizes some of the primary differences a business owner can anticipate between an outright sale versus a private equity recapitalization. Recapitalization vs Complete Sale

Issues Recapitalization Complete Sale

Valuation Full, fair values are achieved where lending Higher values can be achieved with market conditions provide an upper bound the expectation of realizing revenue on value and/or expense “synergies”

Ownership Interest Sell 50% to 90% of the ownership and “roll‐ Sell 100% of the ownership of the over” a retained equity interest typically on a company, with limited chance for tax deferred basis; provide second tier future equity participation management with equity through a stock option plan

Management’s Role Management will retain operational control Nominal transition period is usually of the Company; financial owners typically 6 to 18 months act as advisors at the board level

Capital for Growth Private equity groups are committed to Willingness to invest growth capital investing capital and are determined to varies based on corporate strategy pursue aggressive growth initiatives and resources

Employees Management remains in control of personnel Redundant employees are eliminated decisions, as well as other day‐to‐day as part of the “synergies” between operational decisions companies

Corporate Image Corporate name and image continues and Seller’s corporate identity is often the brand/franchise value is built upon times eliminated, unless significant “brand equity” exists

Private equity recapitalizations may not be the preferred transaction for every business owner, but they do offer a number of compelling considerations to be discussed prior to starting a formal sale process.

To summarize, private equity buyers provide the following deal characteristics for business owners:

 Liquidity: Business owners can realize significant personal/family liquidity by selling part of the business and extracting 80% ‐ 90% or more of their company’s current value, while retaining a disproportionate share of the remaining equity.

 Diversification: Avoids the risks of having personal/family wealth tied to a single business enterprise – allows for prudent diversification of your wealth.

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 Upside: Entrepreneurs can participate in a “second bite of the apple” in 3 to 5 years by maintaining a meaningful ownership stake (30% or more) – by aggressively growing the business, you can create significant additional wealth.

 Management Continuity: Owners and existing management maintain operational control of the business, and with new partners, focus on accelerated growth. An option program can broaden the equity participation to other tiers of management, who would otherwise never become owners.

 Partnership: A well‐capitalized partner with deep pockets and extensive business connections sets the stage for strong growth internally and/or through acquisitions.

About Matrix Capital Markets Group, Inc. Founded in 1988, Matrix Capital Markets Group, Inc. is an independent, advisory focused, privately‐held investment bank headquartered in Richmond, VA, with additional offices in Baltimore, MD and Chicago, IL. Matrix provides merger & acquisition and financial advisory services for privately‐held, private‐equity owned, not‐for‐profit and publicly traded companies, as well as municipalities. Matrix’s advisory services include company sales, recapitalizations, capital raises of debt & equity, corporate carve outs, special situations, management buyouts, corporate valuations, fairness opinions and business consulting. Matrix serves clients in a wide range of industries, including automotive aftermarket, building products, business services, consumer products, convenience retail, downstream energy, healthcare and industrial products. For additional information or to contact our team members, please visit www.matrixcmg.com.

Securities offered by MCMG Capital Advisors, Inc., an affiliate of Matrix Capital Markets Group, Inc., Member FINRA & SIPC

The contents of this publication are presented for informational purposes only. While Matrix Capital Markets Group, Inc. and MCMG Capital Advisors, Inc. (“Matrix”) believe the information presented in this publication is accurate, this publication is provided “AS IS” and without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranty of merchantability, fitness for a particular purpose, or non-infringement. Matrix assumes no responsibility for errors or omissions in this publication or other documents which may be contained in, referenced, or linked to this publication. Any recipient of this publication is expressly responsible to seek out its own professional advice with respect to the information contained herein.

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