Dear Insider,
Imagine you are an owner at the helm of a successful company. You’ve worked hard. You took on the risk of ownership. There were lean years. There were years of plenty. Now it's time to think about where this company that you’ve built will go after you aren’t leading it anymore. 

Many owners of mid-size firms want to preserve the legacy of their firm- selling stock to their management team and bringing their next generation of leaders into partnership. The same people who have helped you build the company, now getting a chance to buy in, taking on the mantle of ownership, and compensating you for this creation you have poured so much time into. However, the most successful of these firms face a significant dilemma: they have become too successful for their own leadership team to afford. 

What can they do? They can sell their stock at a significant discount. For obvious reasons, that isn’t fair to the owner, and it won't be fair to the next generation of owners either when it comes time to sell again. Beyond the transaction, it also weakens the value of stock in the firm which has a variety of negative implications- i.e. the firm cannot compete when using stock to help finance the purchase of another firm. This can damage the long-term prospects of your firm, and limit options for you and future owners.

We call this the dilemma of success. Over PSMJ’s 50 years, we have seen this emerge countless times and as far as solutions can go, this dilemma can get tricky for owners and their heirs apparent. However, in the last few years, we have seen a truly novel option emerge- a private equity recapitalization with rolled equity. It’s a bit of a mouthful, but our sell-side clients have been ordering these by the dozen (if only deal-making was so simple). 

In essence, this ‘hybrid’ solution involves a private equity buyer purchasing a majority of stock from an owner and rolling equity for key stakeholders (the management team who could not afford to buy the owner out). The price differential for successful firms in a competitive market means that the buyout pays what they might have received on an internal sale and more, enabling them to pass proceeds to their internal stakeholders in the form of the very stock that the management team was worried about affording. 

For some owners, this is ideal. Most private equity partners in this space want the management team to retain operational control, preserving the company’s vision. Sometimes they invest in their team members by upgrading systems or introducing them to other teams in the family of similar businesses that may have unique expertise to share.

The results are quite remarkable. That next generation has dodged the risk involved with a massive amount of debt; their stock, although not a controlling interest in the firm, generally goes up in value as they join into a larger entity via their private equity parent company, and the owner gets a valuable payday. These leaders who might have missed out on ownership, now begin leading their company to new and better heights as partners.

Is this for everyone? Certainly not. There are certain markets that appeal to these buyers more than others, and there are thresholds of size in which such buyers are interested. Further, it’s important to consider that the recipients of this much stock will face tax implications. With the right structuring and the right partner, this bill to Uncle Sam can be deferred and is more than offset by the appreciation of the stock.

Here at PSMJ’s M&A Advisory practice, we share these stories with you to help you understand the options that are out there. We hope that you will take these ideas and form them into goals that match your needs, and from there, decide what actions at your firm will help you reach those goals. 

Whether you are faced with this dilemma of success now, or you are imagining reaching that dilemma someday soon, we are here to help navigate the waters of this market. 

Want to learn more about this and other ways to achieve your goals as an owner? Feel free to give us a call or let us know your questions with a comment below.