Balancing Founder Upside and Liquidity via a Minority/Majority Recapitalization

A common dilemma founders of bootstrapped companies face is knowing when the right time is to sell their business. Specifically, they’re faced with the challenge of balancing liquidity and future upside.

On the one hand, the potential upside of a bootstrapped, high-growth company is significant, but having all one’s personal wealth tied up in a single high-value asset presents significant financial risk. On the other hand, liquidating one’s equity too soon limits future upside.

For founders who find themselves frequently revisiting the idea of whether to liquidate or wait a little longer, a third option they should consider is a minority or majority recapitalization.

What Is a Minority or Majority Recap?

A minority/majority recap is when a founder exchanges a portion of their equity in a business for cash (instead of for an infusion of capital to go on the balance sheet). The only difference between a minority/majority recap is in how much equity you sell (less or more than 50%).

In the private investment space, recapitalizations are more common when partnering with private equity firms as opposed to VC funds. VC funds tend to prefer that their investment go on the balance sheet to stimulate future upside for founder and fund. Private equity firms, on the other hand, are more comfortable paying out capital to founders since they tend to partner with later-stage businesses that have a proven thesis.

The Benefits of a Minority or Majority Recapitalization

Minority/majority recaps offer a nice middle ground both in terms of upside and liquidity. By selling a portion of equity for cash, founders can de-risk their personal balance sheet while at the same time retaining equity for future upside.

At what point will the founder realize that future upside? In subsequent exits.

What many founders don’t realize is that the path to exit can be more like descending stairs than jumping ship. When a founder brings on a private equity partner, that partner will have their own exit in mind 3-7 years down the road. When this secondary exit happens (often another recapitalization), the founder can again liquidate a portion of their equity while also rolling some over into a new partnership. This pattern continues until the founder decides the time is right to fully exit.

Growing Upside with the Help of a Partner

Bringing on a minority/majority partner is not just about retaining equity and then continuing with your company’s same growth trajectory. Adding an experienced partner to your board is one of the best paths to accelerate growth, further increasing future upside. Some of the ways a partner can bring value to the table include their:

• Operational expertise. The right PE partner will have previous experience operating and optimizing the functional areas of your company you’d most like to improve.
• Talent network. PE firms have hired and worked with a wide network of talented professionals across disciplines and they’re always happy to make an introduction.
• Sales channel network. Investors will have relationships with potential channel partners and be able to open doors to increase your top of funnel.
• Industry experience. A partner with experience in your industry can fill in knowledge gaps based on their past experience with other portfolio companies.

In many cases, with the right partner adding value at multiple levels in your organization, the "second bite of the apple" can be even bigger than the first bite in terms of a founder’s payout.

Finding the Right Balance Between Liquidity and Upside

The preferred balance between liquidity and upside will be different for every founder. The key to finding the right fit is to ensure you have a full menu of transaction options to choose from so you can identify the partner who best meets your goals as a founder.

Working with an investment bank can help you ensure you have a wide variety of qualified investors/buyers at the table so that, when the time comes to exit, you can choose which option best works for you.