How to Cash Out Without Retiring

One option for entrepreneurs is a leveraged buyout deal. To get started, talk to an investment banker or lawyer about finding potential private equity investors

by Karen E. Klein

What is a "leveraged recapitalization," and how does it differ from a "leveraged buyout"? I'm a small-business owner looking to cash out but not retire. I wonder if one of these strategies would work for me?—B.V., Princeton, N.J.

A leveraged recapitalization is essentially a leveraged buyout, or private equity buyout, says Ken Csaplar, an investment banker serving as managing director at Trenwith Securities. "People throw the terms around, and to some degree they're interchangeable," he says.

These deals involve both outside investors, in the form of private equity firms, and debt financing from commercial lenders. The investors put in a certain amount of money, then borrow an additional amount from a bank and aim to increase the company's value greatly—perhaps tripling it—before selling it. "If the company and the owner and the private equity firm do well at the end of the deal," Csaplar says, "they all come out way ahead."

Leveraged buyouts are often good options for entrepreneurs between the ages 45 and 60, Csaplar says, because the investors typically want existing management to continue running the company. "Most private equity firms hold on to a company for three to six years, so they want people who still have the energy to work hard for a few years," he says. "If an entrepreneur is closer to 70 and ready to retire immediately, the private equity firm might still be interested in the company, but they'd put in new management."

Monitors, Not Managers

Consider this option if your company is financially healthy, with good cash flow, and poised for growth. Csaplar says leveraged buyouts are done on companies from $5 million to $1 billion in annual revenues. While his firm specializes in middle-market deals, he says, "We'd take on a company with $10 to $20 million in revenues if it had great earnings and growth." But even if your firm is smaller, it may be possible to locate investors who will be interested. "There are over 2,000 private equity firms existing today, and they come in all shapes, sizes, and areas of focus. There are more buyers out there than there are good sellers," he notes.

Once you enter into this kind of a deal with outside investors, they will have control over your company board. But most private equity firms prefer to monitor day-to-day operations rather than manage them. "They provide the capital, brains, and resources from outside the company's core competency," Csaplar says. "Most are constructively interactive but not micromanagers." Still, if the firm does not meet the growth targets set up by the investors, the owner may find him- or herself out of a job eventually.

That kind of outcome is unlikely, however, Csaplar says, because private investors tend to be very cautious about entering into deals. "If they believed that failure would be a likely outcome, they wouldn't buy the company in the first place," he says. "The vast majority of them are betting on the management's ability to deliver. They don't want to go in and start changing the management around."

Your Own Due Diligence

Talk to an investment banker or lawyer about how you can locate private equity investors and vet their qualifications. If your firm is thriving, but has been operating under the radar or in a location where there isn't much regional business investment activity, you may be able to find several firms that are interested and negotiate your way into a better deal. Before you sign up with a private equity investment firm, make sure you investigate it thoroughly. Does it have expertise working with other companies in your industry? Is it the right size for your needs? If it has traditionally invested in larger firms, will it give yours the amount of attention you need? If it's used to working with smaller firms, will it try to overmanage your midsize company?

Ask lots of questions not only of the investors but also of the owners of their other portfolio companies. "Call all of the CEOs they've worked with and ask what the experience was like. In my experience, they're quite open and usually fairly happy with what they've been through," Csaplar says.

Finally, remember that these deals are complex, and if you do attract private equity investors, they will be savvy financial operators. It's very important for you to be represented in such a deal by a professional adviser who is familiar with the details of leveraged buyouts. There is always negotiating room, so make sure your interests are protected and that you get the best deal possible: You built the business, after all (see BusinessWeek.com, 6/15/07, "Sell Your Business, Stay in Control").

Karen E. Klein is a business journalist who covers small-business issues for several national publications. She writes her Smart Answers column twice a week.