Cashing In Without Cashing Out: Dividend-Levered Recapitalizations
You own and run a successful company.
You feel strongly that your company will do well, grow and increase in value.
You want to continue to run your business and don’t want or need any, or any more partners.
The company is worth a lot. It may represent 60%-90% of your net worth.
Even though your company is doing well and has rosy prospects, there is always the possibility that things will go wrong and your business will falter.
Having the majority of your wealth tied to a single asset creates great risk. You wonder, “How do I mitigate that risk while continuing to own and run my company?”
A most efficient way to mitigate your risk of wealth concentration is to do a dividend levered recapitalization.
This uses the same financial engineering that private equity firms employ. The difference is that you can:
- Maintain your existing ownership position
- Take almost as much capital out of your company as you would in a PE deal
- Maintain management control and continuity
- Avoid the fees PE firms charge and disruption they can create
An example of how a levered recap mitigates your risk of wealth concentration in your business might go as follows:
- Your company has EBITDA of $5 million
- The Company borrows $20 million – 4x EBITDA – on a NON-RECOURSE basis
- $5 million remains with the business for working capital
- $14 million is paid out to you as a dividend, with ~$1 mil paid in fees & expenses to the various parties to the transaction
- Your cost of capital in today’s market will be 6%-7% above LIBOR
- The multiple of EBITDA and interest rates available improve as EBITDA grows
The $14 million you take as a dividend will generally have significant tax advantages vs. receiving annual profit-sharing at ordinary income rates.
You and your family have greater financial security if anything should happen to your business.
What happens to your company? Isn’t the risk to the business increased?
The answer is, not really.
Management hasn’t changed and the company has adequate working capital to continue to grow and thrive. After taking the dividend out of your company, debt is quickly amortized: not so fast as to eliminate growth investments, but fast enough to “de-lever” your company rapidly.
In the example below, the assumption is that your company’s EBITDA will grow at 10% annually and that you will want to balance debt amortization with growth investments and continued cash distributions to shareholders.
|Company EBITDA||$5.0 million||$5.5 million||$6.0 million|
|Existing Debt||$20.0 million||$19.0 million||$16 million|
|Amortization – Scheduled||$1.0 million (5%)||$1.0 million (5%)||$1.0 million (5%)|
|Remaining EBITDA||$4.0 million||$4.6 million||$5.2 million|
|Amortization – ECF Sweep
(see note below)
|NA||$2.0 million (~50% After Tax Cash Flow)||$2.2 million (~50% After Tax Cash Flow)|
|Ending Debt||$19.0 million||$16.0 million||$12.8 million|
|Ending Total Leverage||3.80x||2.90x||2.13x|
This example demonstrates that by year 2 after the dividend, shareholders can again begin to take distributions from the company, and that the ratio of debt to EBITDA reduces from 4x EBITDA to begin to 2.9x at the end of year two, and 2.13x at the end of year three. Please remember that 1x EBITDA is your working capital line.
2.9x EBITDA – 2.13x EBITDA do not represent a high leverage ratios that should create risk to your business.
In years 2 & 3 after required debt amortization, you have the option to apply the second 50% of after tax cash flow to distributions to shareholders, further balancing your wealth portfolio. You may also apply those funds to growth initiatives.
An alternate path is to apply those funds to faster debt amortization. If this tact is taken, ending debt at the end of year two will be $14 mil – 2.55x EBITDA. At the end of year 3, ending debt will be $10.6 mil – 1.77x EBITDA; a conservative level.
It is important to re-iterate that a dividend recap is a RISK MITIGATION STRATEGY for balancing your wealth between your company and personal holdings.
The borrowings described above are NON-RECOURSE to you. Should something go wrong in your business, you and your family have – in this example – $14 million more held outside your business to mitigate risk to your personal wealth.
This article covers a lot of ground quickly and may leave you with more questions than answers. If you do have questions, please contact Mark Taffet at email@example.com
Mark Taffet is CEO of MAST Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle-market companies. Information regarding specific aspects of the private capital markets has been provided by SPP Capital Partners, an investment bank focused on raising funds in the private capital markets, and an affiliate of MAST
NOTE: Cash payment of Excess Cash Flow (“ECF”) sweep amortization occurs after the yearly audit is completed. ECF is generally defined as EBITDA less the following: (i) capital expenditures for the period; (ii) cash taxes; (iii) principal payments; (iv) cash interest expense; (v) cash management fees; (vi) restricted distributions for each year. ECF is a highly negotiated term of any credit agreement.