Often in the evolution of their business, many companies achieve consistently strong growth, but still have opportunities to grow through organic initiatives and acquisitions. Once companies reach this stage, concerns about the potential conflict between the concentration of their wealth and on-going investment in the business begins to materialize.

Join Eric Mattson, Principal at Exellere Partners, and David Straub, Director of Business Development at Delaware Trust, for a complimentary, one-hour webinar discussing liquidity options for small- and medium-sized, privately held companies, including traditional liquidity options and recapitalization as an alternative.

This webinar is presented by Delaware Trust. Delaware Trust provides a full suite of corporate trust and agency, independent director, private equity networking, and special purpose entity services to corporations, law firms, financial institutions, institutional investors, and private equity firms. Delaware Trust is not affiliated with any bank, lender, or other third party.

View the recorded webinar here.


Recapitalization and Liquidity: Growth Options for Privately Held Companies from CSC


Webinar Transcript*

Anu Shah: Welcome to our webinar, "Recapitalization and liquidity: Growth Options for Privately Held Companies." My name is Anu Shah and I will be your moderator along with Dave Straub. I will now turn it over to Dave to introduce our guest presenter, Eric Mattson. 
Dave Straub: Hello and thanks for joining us today. My name is David Straub and I'm a Director of Business Development for Delaware Trust Company. Joining us today is Eric Mattson from Excellere Partners.  
Eric, I was reading your bio and it's quite lengthy and I know that you're fairly new to the private equity world. But I think it would be nice if you could cover the relevant pieces of your bio that relate to our diverse audience.  
Our audience today is made up of founders of companies, attorneys and some other service provider positions. Eric, with that, if you could just cover the pieces that this audience might be interested in. 
Eric Mattson: Thanks, Dave. As I like to refer to it, I have the merger and acquisition industry a bit surrounded. 
I spent the first 13 years of my career as an investment banker representing entrepreneurs, both doing valuations, managing a valuation practice and also executing M&A transactions, predominately on the sell side, again representing entrepreneurs.  
I then spent 11 years in the industryin a variety of businesses, both middle market and quite large in corporate development and strategic planning. The primary activity, as you can imagine, was executing acquisitions for us, strategic acquisitions and also managing divestitures.  
Then the last almost four years I've been here at Excellere Partners in private equity, on the buy side, focused on recapitalization transactions with founders and management teams.  
Dave: Great. Thank you. The next slide gives a little bit of information about Delaware Trust Company. So, Delaware Trust is a wholly owned subsidiary of Corporation Service Company or CSC. In the corporate trust space, we provide a host of services to M&A transactions. Some of those services are listed here.  
Today, our webinar series really pertains to the first bullet point and that is our private equity networking initiative. That is where we look to match companies that are interested in growth or buyout capital with companies that have it.  
My parent company's corporate clients that are attending, that are interested in growth or buyout capital, and then Delaware Trust an array of private equity firms that are in a position to help companies reach their objectives, their growth objectives. 
Eric, we're going to jump into your presentation now. 
Maybe you could start with either types of companies you've looked at in the past, your past experience, or the firm you're with now, just so that we have a sense of where your experience is in looking at sizes of companies. 
Eric: Sure. This is obviously a very oversimplified illustration of a dynamic, that we see, that happens as entrepreneurs progress down the ownership pathway.  
Over time, we have both the business and the entrepreneur or ownership group maturing and as it happens, there are these opposing forces at work that start to affect both the growth potential of the business potentially and/or the personal satisfaction of the owner, or owners, who are engaged in that business. 
This creates a dynamic where liquidity and thinking about exit planning becomes increasingly of paramount importance, and consuming the thought process of the entrepreneurs.  
So, just to take a slight step before we move on, a slight step to the side and I'll come back and answer your question Dave, is the notion of recapitalization, which within the corporate finance world is a very well-known, well-understood term. But what we've come to learn over the years is that for business owners it's not a very well-known term.  
Quite simply as we think about a recapitalization or you'll hear me abbreviate it to "recap" simply, by definition, it's a corporate reorganization involving a substantial change in the company's capital structure.  
Specifically what we're going to talk about here, as it relates to private companies and private equity, I think that we would further clarify that definition where a large part of the current shareholder's equity is replaced with a combination of new equity from the private equity firm and debt.  
With that, just a quick circling back to Excellere. Very briefly, we're a Denver-based private equity firm. We were founded in 2006 specifically to partner with entrepreneurs and invest in founder-led businesses through recapitalizations. We made our first investment in 2007. In total, we've completed 17 recapitalizations and another 35 add-on acquisitions.  
We operate in a space in the broader private equity ecosystem that one would consider to be the middle market, or even the lower middle market, where most of the businesses that we're having discussions with would have revenue, literally the range is from about $10 million of revenue up to about $300 million of revenue.  
Narrowing that down, for Excellere, is more in the $20 million to $100 million revenue range. I would say broadly speaking, the predominance of private equity would be, kind of, $10 million of revenue up to a couple of hundred million dollars of revenue. 
David, does that kind of address that initial question you had? 
Dave: Yeah. I think it would be good if you could dive a little deeper into the business owner challenges. 
Eric: Yeah. We can certainly serve a back to size because it is relevant, especially as it relates to the technical structure of a recapitalization. There will be opportunities for us in some slides downstream here to dig into it.  
So just a slightly more detailed illustration to the first balance slide, again, just to leave you with a visual that what really starts the discussion here are these competing priorities. What we see, as entrepreneurs, starting to really question what they're going to do, going forward. Early in your ownership, these questions would have really never would have been asked, you're a risk taker and you're growing the business and there's nothing else that you're concerned with.  
Here you start thinking do you plow the cash back in the business or do I distribute it out? Do I setup incentive plans to retain or attract management as the business grows? Does it make sense for me to build that new facility? Do you invest in a true succession leadership team which, in many cases, needs to be years ahead of a contemplated exit?  
These are tough questions, and what makes it even tougher is that there really is no right or wrong answer. It's all situational. What's relevant here to our discussion about recapitalizations and liquidity, is that it's these contemplations that, as I mentioned earlier, is what generally gets the thinking started. Ultimately it's the degree to which these competing elements are weighing on you, that dictates the appropriate course of action as it relates to liquidity.  
Here I have a slide that really just addresses, it's not meant to be all-encompassing, but it's really meant to highlight the traditional liquidity options that have existed for entrepreneurs. You'll notice that recapitalization is conspicuously absent here. We're going to get to that because a recap is a bit of a hybrid.  
Just to cover these very quickly when we think about 100% sale or a buyout, as some folks may refer to it, it's really best suited for owners who want to completely exit the business.  
It most often results in the greatest proceeds at that time, but obviously there really is no, or very little, opportunity to participate in the future potential upside for the business. I think most people when they think about exit planning go down that pathway, and it's completely understandable and the most common pathway.  
Going counterclockwise from 100 percent sales as a public offering or an IPO, while it's nice to think about an IPO, generally we're dealing with much larger businesses. I think, excluding biotech or technology, in my opinion I think to be a legitimate IPO candidate you've got to be looking at an evaluation north of $500 million. That's just not a space that we play in. I think for most private business owners, that's sort of a distant opportunity.  
The other really kind of important thing a lot of people don't realize with IPOs is that it's really not a liquidity event. Most of the selling shareholders have very strict covenants on them and restrictions on the timing and when they can move their shares.  
The business has to actually perform over typically a 24-month period of time before any true liquidity can start to be realized. So, it's just an important thing to keep in mind.  
ESOPs, and Dave, I don't know if you've had a course on this in the past. This could really be its own seminar or webinar. I'm not going to get into it. It's a really complicated animal. While it can create liquidity, at least some degree of liquidity, in almost all cases it's not 100%.  
In all of the instances that I'm familiar with, and I was part of a couple of ESOPs in a past life, the selling shareholders have to actually guarantee the debt that's used to fund the share purchase.  
I think that one is "proceed with caution". They tend to be more applicable in situations where a business is a difficult business to exit, a lumpy revenue stream and other dynamics that make it more difficult to exit in traditional fashions.  
Lastly here, I'll just address a minority transaction. Either a minority sell of shares or could even be mezzanine or subordinated debt where, as a part of putting that debt in place, they take a piece of the company.  
Here, just be aware that while it's nice to think about getting a little bit of liquidity, taking those chips off the table and remaining in control of the business, which clearly you as a business owner would remain control, the cost of that capital is considerably higher than through some of these other exit opportunities. 
That's just a real quick flyover and it's meant to be done . . . We're going to hit, in some subsequent slides, these again and it's meant to compare and contrast with what we're here to talk about primarily, which is a recapitalization.  
As I mentioned before, it's a hybrid option, of sorts. Let's just kind of tick down some of the more relevant elements as we think about what a recap represents and where a recap is most applicable.  
Those include when the shareholder or shareholders, or some subset of the shareholders, want a liquidity event, want to take chips off those tables, but also really have a desire to stay involved in the business and reap the rewards of the future value that they see, and three, they recognize that the best pathway to get there is to bring on a partner with the resources to help accelerate that value creation. 
What we have illustrated here, are really what we see as the five key elements of a recap, which are you have to be willing, by definition here, you're taking on a partner that you'd want to work with to help drive the growth, and that partner that's coming into the relationship with capital and hopefully other value-added resources.  
In today's market, capital is really plentiful.. Capital is the purest form of commodity, so if the only thing a firm is bringing is capital, then they're not really fulfilling what we think is an important qualifier of having some value-added resources to help accelerate that growth.  
Secondly, there will be a significant immediate liquidity event for shareholders, at the time of closing. I've got an example a few slides down where we'll walk through the number so you can get a feeling for what significant immediate liquidity means.  
Next is ownership. While your new partner will have statutory control, I think it's important, and we certainly feel that, the best situations where we're aligned in driving future value because, obviously, we're coming in and investing cash equity in the business, and there will be an expectation for some continued ownership on your part.  
So that alignment creates a dynamic where, hopefully, we're all rowing the oars in the same direction, which leads into operations. While the private equity partner here executing the recap would have statutory control, really in the vast majority of cases that I see, clearly in all of the cases with Excellere, it's the leadership team that's in place today that retains operating control of the business. 
Lastly and perhaps the most important part here, is that alignment and rowing the oars in the same direction will lead to a significant future liquidity event or as we like to call it, a second bite of the apple.  
What we see here is just, again, another illustration of what I mentioned earlier and just a slightly different take on it, with regard to that balance of owner's contemplations and what happens over time.  
At the founding of the business where risk is high, and the growth potential is infinite, there is a gap. As I mentioned earlier, you don't even ask yourself those questions about where you're going to invest your time and your resources. 
But over time then, as the business matures, and as situations in the owners' lives or the shareholders' lives change, that tolerance for risk we see tends to come down and the business reaches an inflection point. That's where the two lines here intersect. That's the point at which a recapitalization really can come into play and be that best-of-all-worlds model.  
In this next slide, this similar version to what we were just looking at, what you see at that inflection point are a couple of really critical points, to keep in mind, as you think about a recapitalization. One is that the business at that inflection point had continued runway for growth.  
As the owner, you were recognizing that you have a vision for where to take the business, but it's that lower-risk tolerance that was creating this inflection point and deeper thinking around where, and how, to achieve that growth.  
With a recapitalization, essentially what happens is, with the gold line — the risk tolerance line, when we come in we've taken all future financial risk off the table. So at that point in time, you've achieved a liquidity event, and there is essentially no further future financial risk.  
At the same time with the resources that we bring to bear, we're able to bend that growth potential curve and achieve incremental growth. This is a theoretical case.  
We have a case study at the end of the presentation that, hopefully, will shed light more specifically on the kinds of things that come to play, that help make that happen. But I think this is a great visual just to keep in mind as we think about the upside related to a recapitalization transaction. 
Dave: Eric, I have a question related to that last slide, the uptick there, the inflection point there. Knowing that your firm will hold on to the investment for three-to-five years, how quickly after transition takes place, do you actually on average begin to see results? 
Eric: So, that's a great question. I actually have a slide that speaks to that a few slides down. So, I'll hit it here and then we'll hit it again.  
Our approach is that we're not looking for an immediate uptick. There's a notion that we have, and I think it's shared by most private equity firms or most successful private equity firms that do recapitalizations, where you want to make sure that a foundation is in place to be able to digest the growth.  
Generally for us there's a six to, maybe, 18-month period of time where we're investing in the business and we're making sure that foundation is solid, before we start focusing on growth.  
So we're really not looking for that uptick, the serious bend in the curve until probably the middle part of year two of our investment. Then we're going to have proof of concept from years two through three or four. That's about the time that it generally, in our model, makes sense to sit down and talk about appropriate timing for that second bite of the apple. 

Eric:. Just again, it was mentioned earlier, you'll have the opportunity to download the PDF. I'll let you do that and come back and review some of these things in depth. 
Just ticking through, starting at the very top and going around counterclockwise, these are the key elements that help establish whether or not a recap is a good situation for your business.  
One is that you have to have positive cash flow, and ideally you'd have had positive cash flow for at least a few years going back, and able to satisfy everybody, that left positive cash flow going forward.  
Moving on, you or some subset of the current owners should have a genuine interest in remaining active in the business. Next, it really is beneficial if your business has some kind of differentiable position within its core markets. Is there a niche that you occupy, where you have some degree of leadership? That's really helpful.  
Next, your customers should adore you and be willing to sing your praises. For us, this really gives us great confidence that what we're going to be investing in is truly a great business that we can put our resources behind, and scale and build it.  
Next, it's helpful if there are other senior managers beyond the owners that are involved in the business and legitimately have decision-making authority over parts of the business.  
Actually for us, for Excellere, this is the least important concern. We're a little bit more of a roll-our-sleeves-up-and-get-involved kind of firm. But because it, in some cases, is the most important element for many private equity firms, we think it's important to address it here.  
Next, as I mentioned, you really have to have an interest in taking on a partner. Again, hopefully that partner is bringing complementary resources to the table. Then lastly, the business, there has to be a pathway for growth.  
The very first valuation assignment I had, a really long time ago, was a business that transferred musical tape to albums. That was right at the time that compact discs were starting to be introduced to the market. There was really no growth pathway for that business.  
Now, I know today vinyl is coming back, but 28 years ago, that business had missed its window and, regardless of all the other components being in place, there really wasn't much anybody could have done to have a successful recap there.  
One last point with regard to this slide is that it's not required that all of these things be in place. Please keep in mind that these are the elements that help to define those characteristics that would lead to a more successful recap, if you will but they clearly don't all have to be in place to pursue a recapitalization. 
This next slide is again really kind of summary of much of what we just covered. I'm not going to spend too much time here. You can come back and spend more time with the printed version. It's a quick visual comparison of the various liquidity options we've talked about.  
As you think about which of these liquidity options, across the top, may work best for you in light of evaluating those key contemplations down the left hand column. It helps to zero in on those one or two or three liquidity options that might make the most sense.  
Clearly, as you can see in that final column, we're big fans of the recap. In our experience, as I mentioned before, we consider it to be a best-of-all-worlds option. But again, it's not the only option. Understanding the pros and cons of each are really what matter as it relates to your personal situation.  
So, I mentioned that we were going to talk about a real life example with numbers. That was kind of a half-truth. So without representing what this 100 represents, for you it can literally be 100 or it can be 1 million or it can be 10 million or it can be 100 million. We're using numbers here that are easy to translate into numbers that may make more sense for you. So not only is it easy math for me to work with, but its easy math for you to work with, if you want to take this and apply it to your personal situation.  
Let's just remember the key elements of what we're talking about here with the recap. There's a significant liquidity even combined with significant continued ownership. That's what I'm going to focus on here. Just to orientate you with this table, I know there's a lot going on. Down the columns on the left, those are the key elements that make up a recap.  
What they include is a business's current valuation, the amount of debt that's going to be used in the recap, the amount of cash equity that's going to be coming in from the private equity firm. Going down, the amount of the seller's rollover equity that they're going to basically contribute into the recapitalized entity, and all of those, from seller equity/rollover stock on up, would really aggregate to what we would consider to be the first bite of the apple. So that's the initial transaction.  
Then what we have down below is the future value of that rollover stock. That is not the future value of the business. That is just the amount of the rollover stock that came from the original first bite, from the selling shareholders. That's what we would call the second bite of the apple.  
In just going through the pre-close and post-close examples, the pre-close is very easy. It's a business that's been valued at 100 and if we were talking about a 100% sale, that's what it would be.  
At closing, there would be a sale for 100%. Based on your business, 100% would equal 100. Based on the business, you would get all or some component of that at closing, or there may be contingent payments that would come as a result of that.  
In the post-close column, which really speaks to a recapitalization, what we have here is the structure of the recapitalization, so an initial valuation of 100. What gets paid out to the sellers at closing is the 80.  
That 80 is made up of 30 that would come from the recap partner's cash equity, and 50 that would come from debt. That gets paid out entirely as liquidity to the sellers. Here you have 80% of the then current valuation in the business coming out in liquidity. So, that's cash that goes to you.  
The remaining 20 is what we consider the rollover equity. This is a little bit of math that's not very intuitive, but because the total equity going forward in the new entity is 50, so if you take the 30 from the recap partner and the 20 from the selling shareholders, that equals 50. Your 20 of that 50 equals 40%. 
So on a go forward basis, you've essentially sold 80% of the business and you've retained 40% of the business. That's the power of leverage that's used in a recapitalization.  
I should underscore that we certainly have a philosophy on moderate amount of leverage. It has to be leverage that's appropriate for the cash flow of the business. If you over-lever a business to maximize that initial first bite, you geometrically increase the risk associated with not being able to cover the debt payments, and bad things happening with the business.  
So the first bite then comes out to the shareholders at 80. There's a lot of math that happens to get to the next line. In this example, what we've assumed here is that, over the course of our ownership period and our partnership period with you, we've been able to triple the value of the business, which is not uncommon.  
I know that may sound like that's pie in the sky, but that's really a middle of the road outcome for us. I would say, again, not to just make this an Excellere commercial, but for other successful private equity firms, our experience or observations are that that's not an uncommon expected outcome.  
Again, with some complicated math that doesn't warrant going in to too much detail here, at the end of the day, that 40%, after we've paid off about half of the original debt, amounts to a second bite of the apple of 110 million. There I did it, I went to million. Sorry about that.  
For a total achieved valued of 190. Here in this example, again, very common with what we experience is that second bite of the apple is actually a bigger bite than the first bite of the apple.  
One of the things you may be asking yourself is, what are those things that we do to drive value? The first two arrows on the left there really relate to the business dynamics going in.  
These are the elements that exist at the time of investment, where it's an industry that we like, it's a business that has those dynamics that I described before.  
Here is that slide I mentioned with regard to foundation that we start to build upon. We start to make sure that we're investing in people, processes and technology, so that we can initially launch on the lowest hanging fruit, which is generally what we refer to as organic growth.  
It's entering new geographies. It's getting to new markets and its achieving higher margin on what we're selling because we're doing it more efficiently. Once there's proof of concept around that, we will continue to build that foundation, and launch into the buy part of the buy, and build strategy or acquisitions.  
It's imperative that when we start to do add-on acquisitions that we've got the team in place, that we can successful integrate that acquisition, and make sure the promise of those synergies are realized.  
I'm going to move through this slide really quickly. This is again just in review and I think it's a good slide to go back to from a printed copy. There's one element here to note that has to do with the incentive stock. I didn't really cover it in the recap model because it's a notion that just adds complication.  
But just be aware that philosophically, for us and again, I think it's very similar for most private equity firms that execute recapitalizations, that there is some notion of reward for the team that helped get you there. Also, a very strong desire in retaining those people that should be retained, and incentivize them with the future upside. In many cases, that incentive stock for that group of people results in material, economic, results at that second-bite-of-the-apple stage.  
Just to wrap this phase, at the end of the day it's a complicated process. To give you a degree of reference, for every investment that we make, and our metrics are very consistent with private equity industry statistics, is that we're going to look at — seriously evaluate, somewhere in the neighborhood of 100 opportunities to make one investment.  
So, to the degree that you all start discussions down a path where you haven't properly vetted the people of the firm, the culture of the firm, the strategy, their capabilities, you're going to make those, what are already long odds even longer.  
It's really important that there's self-reflection and that you are able to articulate and define what kind of partner you want. Do you want a partner like us that's going to roll up their sleeves and help execute on that growth strategy, or do you just want capital? Do you want someone that has operating partners or do you want somebody that brings in consultants.  
These are all, from afar, private equity firms all look alike. Literally here in Denver, of the 15 private equity firms, I think 13 of us have mountains on our website. So we literally all look alike. As you get closer, there are a lot of nuances and it's important to understand what those nuances are. I think I'll just take an opportunity here to also just underscore the difficulty in getting transactions accomplished.  
Dave, I know you really breezed through your slides, so just to let everybody know that to actually get to the point where we make an investment, it takes an army and that army is made up of a lot of very talented service providers.  
So I can't thank you and your team enough for what you bring to the table and helping us get things done, including a transaction that we closed just a couple weeks ago. So, appreciate all your expertise and what you do. 
Eric: I am going to now sort of click through and again, to give us enough time for appropriate Q&A, talk about one of our investments, which is MedExpress Urgent Care. Back in 2001 the business was founded; they were really a pioneer in urgent care.  
I think today it's hard to drive a mile in any kind of urban area without seeing one or two urgent care centers. It's really been a model that has taken off. This was a business that four physicians from Morgantown, West Virginia founded.  
The lead physician, Dr. Frank Alderman, as a teenager, actually worked at the Greenbrier which is a very high-end and all-about-service resort. As he looked up being a healthcare provider and just saw the deplorable conditions that patients were required to subject themselves to, to receive care, he really sought and had a vision, to turn that upside down.  
Not think of patients as patients, but think of them as guests and create an environment where that experience was something completely different than anything they'd had before. And incent people to come to his urgent care clinics. As opposed to making appointment, going to a primary care physician or going to the emergency room.  
Over the subsequent five, six years, they built this business that, at the time we started talking to them, had seven locations and really had this vision for how this could be a national player.  
As you can see on the quote down there, Frank himself really talks about this inflection point that they reached, and they still had the passion to be a part of the business, but they knew that they needed additional resources to make that happen.  
So, when we look at the results of our partnering with Frank and his partners at MedExpress, just kind of ticking through from far left to far right, we over the course of about three-and-a-half-years grew from 7 clinics to 48 clinics, from 200 employees to over 1,400 employees. Revenue: very dramatic revenue growth from $14 million at the time of our involvement to over $140 million and very dramatic increase in patient visits. 
How did we do that? First with the foundation, as I mentioned earlier, we invested of the cash flow coming out of the business, we took that cash flow including additional capital that we put in to the tune of about $7 million, just in corporate infrastructure because, we knew the growth was coming. We knew we could really ramp this up.  
A key part of that is we added people that were specifically tasked with engaging with payers, and really selling them on the story of a better mousetrap. That it was better for the payer to have their patients come to our urgent care clinic than it was to go anywhere else, and to not require us to go through prior authorizations, and other measures that health insurance companies have in place to control spend.  
So, that happened first. We then were able to have proof of concept around the organic growth, which was putting in our own centers, and could this team really manage a growing business. We did that. It was less risky for us to put a new center in a new [MA2] location, than it was to acquire. We made it through that proof of concept.  
Then lastly we started to make acquisitions. At that point we had total and absolute confidence that we were doing the right thing and that we had the team that could manage it.  
I'll just share with you the public information because this is really a success story for Frank and his partners, as much as for Excellere. But we exited the business, again, in about 2011 to two private equity firms that partnered to invest in it. Frank and his team, again, rolled and were seeking a third bite of the apple.  
I can tell you that the third bite of the apple was a sale to Optum for right about $1.3 billion. So, eight years after our partnership, a little less than eight years after our partnership with Frank and his team, they went from a $14 million, seven-location business to over $1 billion valuation. 
So, that's really a testament to the kinds of growth that can happen when that alignment is in place with your recap partner. Again, happy to take any further questions on that.  
I've got a nice quote here from Frank that talks about some of the things that I was referencing with finding the right partner. Clearly it was a great partnership in this instance.  
Anu: Eric, thank you. That was great. Dave, thank you as well. That is all the time we have today. Thank you to everyone who joined us today. We hope to see you next time.