FOR AND AGAINST RECAPITALIZATION

Recapitalization is the financial reorganization of a company's debt and equity mix. The aim is to improve a firm's capital structure. Essentially, the process involves the exchange of one form of debt or equity for another.

FOR RECAPITALIZATION

Stabilizing the Corporate Capital Structure

In distressed situations, a recapitalization can stabilize your firm's capital structure and cash position. This can be achieved by renegotiating terms with lenders by trading existing debt for new debt with lower interest rates or longer maturity; or by simply exchanging debt for common stock.

Providing Liquidity

By raising debt or equity a company consequently increases its liquidity that may be needed to finance further investments, or even an owner's partial or full exit.

Partial Sale of Your Company

A recapitalization gives you the possibility of taking cash out of the business, by selling a minority or majority stake in your company. In particular, owners may consider this option a few years ahead of retirement.

You can earn a pay day today, along with another pay day in a few years time after new investors have hopefully grown the company and increased the value of your retained equity stake. As an owner, you get to take cash off the table, reduce your risk and diversify your investments. An owner would typically be tied to a management position in the company for a period of time.

Bringing in a Capable Partner

In an equity recapitalization, you benefit from the strength of a new owner. It is important to take time to identify the right investor to partner with. You should investigate their previous experience, track record, credibility, motivation and financial stability.

If both parties share the same vision for the future growth of your company, you can benefit from the new equity investors' broad range of operational and strategic experience, as well as their investment dollars.

Increasing Management Discipline

Increasing your company's debt leverage often has a disciplining effect on management as a result of the financial and operational restrictions involved. This discipline can trigger more thorough financial analysis before major decisions.

AGAINST RECAPITALIZATION

Operational and Financial Restrictions

If you choose to raise debt rather than equity, it will bind your company to financial covenants in the credit agreement and place restrictions on investments and distributions to owners imposed by the lenders. Furthermore, costs increase as lenders charge monitoring and maintenance fees on the loan.

Loss of Control

New equity investors (even minority investors) are going to be involved in important strategic and financial decisions. Owners can become frustrated with the direction of new investors. As part of your due diligence, you may even want to talk to other entrepreneurs who have partnered with your new investors or sold companies to them in the past.

Loss of Strategic Focus

In some cases, new equity investors will focus almost entirely on the financial performance of the business. Often, they have limited partners in their equity fund, who expect a minimum rate of return on their investment. On the plus side, their focus on financial rewards should lead to a great second pay day in a few years. On the downside, you may feel that you are abandoning the way you have successfully run your business over many years.

In summary

Recapitalizations are a great tool and often provide the dream exit for a business owner. However, it is a lengthy and time-consuming process, so you may be well served by seeking advice from professionals who have been through the recapitalization process countless times before.

ClearRidge has a strong track record in recapitalizations. Our team works together on every project and we can all pool our ideas to help you determine if a recapitalization is the right tool for you and your stakeholders.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge provides Restructuring, Corporate Finance, Merger & Acquisition and Turnaround services for midsize companies.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes advisory for raising and replacing senior, subordinated or mezzanine debt, as well as raising and replacing equity to provide the lowest cost of capital.

Mergers & Aquisitions includes buying, selling, merging and valuing midsize companies.

Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management.

ClearRidge provides Top Tier advice and relationships with Middle America values and work ethic.

We have directly owned, operated and managed midsize companies. We know the business from your perspective.

Poor M&A Environment and Credit Defaults - 2009 Review & Predictions

Two reports this week.

The first is the ACG and Thomson Reuters' Survey that was released last week.

The second is an extract from Carlyle Group's recently published 2008 Annual Report.

These reports give an insight into the state of Mergers & Acquisitions activity and the performance of Private Equity companies.

As always, we add our ClearRidge summary, review and interpretation.

FIRST UP - ACG Reuters Report

ACG and Reuters announced last week their latest report on the state of middle market Mergers & Acquisitions.

The survey comprised 703 middle market investment bankers, private equity professionals, lawyers, accountants, corporate development officers and business consultants.

Poor M&A Environment

88% responded that the current M&A environment is Fair or Poor. This is worse than the 86% who responded fair or poor in December last year.

Covenant default on credit agreements

14% responded that 25% to 50% of portfolio companies are in covenant default on credit agreements with their lenders.

3% responded that more than half of their portfolio companies are in covenant default.

Turnaround Professionals

40% of private equity firms have retained chief restructuring officers, turnaround consultants, or operating partners to help their portfolio companies, with 16% of private equity firms hiring all three.

In the next 6 months

* 52% predict M&A Activity will increase moderately, 34% predict activity will remain the same, while 10% expect a further decline.

* Half of those surveyed predict that 26% to 50% of M&A deals will be distressed sales. 14% predict over half of M&A deals will be distressed sales. Manufacturing and Distribution: 22% predict that manufacturing and distribution will experience more M&A activity than any other sector and 36% predict manufacturing and distribution will present best opportunities for buyouts.

In the next two years

* Consolidation in private equity firms: 72% predict "Significant Consolidation" in the number of private equity firms.

Private Equity Insight from The Carlyle Group 2008 Report

The following is an extract from Carlyle Group's recently published report. The Carlyle Group is a global private equity investment firm, based in Washington, D.C., with more than $91.5 billion of equity capital under management. While this is not necessarily a reflection of all US Private Equity firms or our views at ClearRidge, these three paragraphs certainly make interesting reading.

"In 2008, the financial landscape changed-and it will remain changed for the foreseeable future. Operating conditions for our portfolio companies will remain challenging. Transactions will be fewer and smaller. More equity will be required and debt terms will be less favorable. And hold periods will increase while returns will decrease. To be sure, these are extraordinary times."

"On its face, the private equity industry doesn't appear to have altered much. But look closer and the changes begin to appear: deal flow has slackened; exits are fewer; investors are hesitant to commit fresh capital; stock prices are down; and debt and equity valuations have been hard hit. Some portfolio companies have restructured, sought bankruptcy protection and even liquidated."

"We continue to believe that within every challenge lies opportunities. Our mission is clear: we must deploy our resources to protect the investments we have already made while seeking ways to profit from the extraordinary opportunities that exist in the new environment. This we pledge to do, all while maintaining the discipline and diligence that are hallmarks of this firm."

The Carlyle Group operates four fund families, focusing on leveraged buyouts, growth capital, real estate and leveraged finance investments. The firm employs more than 575 investment professionals in 21 countries with several offices in the Americas, Europe, Asia and Australia; its portfolio companies employ more than 415,000 people worldwide. Carlyle has over 1200 investors in 68 countries. Source: Carlyle Group website.

ClearRidge View on M&A and Business Valuations

Distressed Mergers & Acquisitions

The reality is that there are many distressed deals on the street right now.

Buyers are seeing many opportunities. It is a real challenge to determine, which "cheap" deals represent good value investments.

Historically, acquisitions made in a downturn result in the highest returns for acquirers, but thorough business due diligence is more important than ever to make sure a deal makes sense.

You need to be confident there is a viable core business.

Acquiring a company for a great price is not a good enough reason for an acquisition.

Middle Market Company Valuations

Surprisingly, valuations of healthy companies remain strong, but as we have discussed before, there is a difference between a sale price multiple of a company's EBITDA and the sale price.
If EBITDA was $5 million last year and the valuation multiple was 6x EBITDA, then in the most simple terms, you could anticipate a sale price of $30 million.

However, if your revenues have dropped 30% in 2009 and your projected EBITDA for 2009 is down 50% to $2.5 million, then the same 6x EBITDA valuation multiple will give a sale price of $15 million. Are you going to sell a $30 million company for $15 million? Unlikely. Unless you have to.

In which case, fewer healthy companies with a short-term dip in EBITDA are going to sell in 2009. Most will wait to see what the world looks like in Spring 2010 when sales and profits are hopefully growing again. Sell the company in Spring 2010 on full-year 2010 projections and you could get close to $30 million again.

So, most companies that are selling in 2009 now are those that have to - those that are in distress.

If you want to sell a healthy company in 2009, you need to be more creative. Instead of requiring cash payment at closing, you need to consider a combination of cash, seller financing, stock and warrants.

Where possible, try to further increase price (cash, stock, warrants) for special consideration and intangibles, which could include significant market share, customer relationships, brand name recognition, or other intangible that sets your company apart from the rest.

Getting your deal done is an art not a science. Every company is different, every situation is different and every deal is different.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge provides Restructuring, Corporate Finance, Merger & Acquisition and Turnaround services for midsize companies.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes advisory for raising and replacing senior, subordinated or mezzanine debt, as well as raising and replacing equity to provide the lowest cost of capital.

Mergers & Aquisitions includes buying, selling, merging and valuing midsize companies.

Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management.

ClearRidge provides Top Tier advice and relationships with Middle America values and work ethic.

We have directly owned, operated and managed midsize companies. We know the business from your perspective.