Non Control Investments Getting Attention

by David Cohn

As Managing Director with Mosaic Capital (www.mosaiccapital.com), a Los Angeles based investment bank and a survivor of several recessions; I would like to share with you a true story, though the circumstances were not unusual, the opportunity it created was. Despite the current economic situation and stagnant lending markets, liquidity options for business owners are still available which has not always been the case under these circumstances.

While a full majority exit may not make sense for 97% of the mature businesses at this time, a few private equity firms will structure a minority investment that would provide a significant liquidity event, while at the same time allowing the key shareholders to maintain daily operating control and majority ownership of your business. Prior to this, it was rare to find a shop to consider such structures.

A Case in point
Over the past thirty years, the Smith Brothers, both in their late 60’s, dedicated their lives to continue the growth of the family plumbing business originally started by their father. For the past several years, they have been bombarded with letters of solicitation and offers to sell their business to both strategic and financial buyers at highly attractive EBITDA multiples. The Smith brothers have a sister who owns 25% of the outstanding shares and has never worked in the company, nor received any distribution or pay.

In July of 2008, they finally entered into serious negotiations with a financially qualified buyer that had offered a handsome multiple for the business. The Smith’s took several months to mull over the concept and finally elected to move forward. Unfortunately, with the tightening credit conditions and a worsening economy, the buyer walked away from the deal in September. The door slams shut.

As the months go on, the company experiences flat sales, and the owners still need some liquidity even though they can’t sell the business for a price that’s even reasonable. No signs of an “uptick” and certainly no signs of a buyer.

Scene II - A few private equity firms enter the scene with what is called a “SMAC”.  Structured Minority Alternative Capital. A SMAC is structured to provide all-cash at a close for a minority stake in the business, with an opportunity for additional consideration to the current owners, if and when the company achieves certain performance hurdles. This form of partnership enables key, but otherwise illiquid, shareholders to take some chips off the table, be aligned with a capital partner to support growth, and enable them to sell a majority position in more robust economic times. These SMACs are structured in many different ways, but they all have at least two requirements in common; stable management and a goal to sell in a few years when things improve. Some private equity shops are now thinking “In these times, would it be better to keep the key shareholders tied to the company financially and just own a minority stake?” and answering “Better to have “SMACed them than buy them…”