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Not Ready for Prime Time

A most critical year for Macon Brock and Doug Perry was 1993. They had already sold K&K Toys, a company …

A most critical year for Macon Brock and Doug Perry was 1993. They had already sold K&K Toys, a company they co-founded 23 years earlier, to concentrate on Dollar Tree Stores, a discount retailer that sells merchandise at the $1 price point. That chain was unveiled in 1986 and was growing quickly, already up to 300 stores. As chief executive, Brock was trying to figure out a way to capitalize the next wave of growth. He considered an initial public offering and a strategic partnership before finally choosing private recapitalization.

In a private recap, an entrepreneur-owner can get cash for his company and still retain a large ownership position. In effect, Brock sold 50 percent of his firm to Saunders Karp & Megrue, a New York-based merchant bank specializing in private recaps, and retained control of the company.

“At the time we didn’t feel the company was ready to do an IPO,” explains Brock. “The private recap route was preferable given our needs and what we wanted to do going forward. We wanted to stay with the company, not give up control, restructure debt, and reorganize the company.”

The recap was so successful that two years later, in March 1995, the company finally undertook an IPO, selling 2.5 million shares of common stock at $15 a share.

“We went public sooner than anticipated, but the reason that came upon us was that we so successfully expanded the chain,” Brock says. Indeed by 1995, Dollar Trees’ sales jumped to $300.2 million and 636 stores. It was also a good opportunity for Saunders Karp to begin to cash out. Private recap companies hold several exit options, including a private sale, a second recap or an IPO. For a growth company such as Dollar Tree, an IPO in 1995 made a lot of sense. By February 1997, the company was operating 748 stores, sales were about $500 million and stock was trading in the $40 range. The company projects 880 stores and $600 million in sales by the end of this year.

“We would have continued to grow the company, but not as quickly without the private recap,” Brock says. “We got experienced partners, and as original founders, our personal wealth was no longer solely tied to the company, so we could be less conservative.”

Before the recap, Dollar Tree was growing rapidly, recalls John Megrue, a partner with Saunders Karp. “An entrepreneur can grow a business more rapidly when he has secured his family’s future by taking money out of a deal. He can now think about swinging for the fences where before he couldn’t grow as fast because he might lose everything he owned.”

Entrepreneurs use private recaps when considering asset diversification or estate planning. That was one of Ron Simon’s considerations when he turned to a private recap in 1994 for his rapidly expanding company, RSI Home Products. The CEO of the Newport Beach, CA, manufacturer and marketer of assembled and ready-to-assemble kitchen and bathroom cabinets wanted to “get some personal liquidity” and still have a business to run and grow. Like Dollar Tree, he considered an IPO, but the company was only five years old with $50 million in sales, and the hassles of being public including keeping one eye always on the stock price weren’t commensurate with where the company was in terms of development.

With a private recap, your personal worth is not a consideration anymore, because it is  already taken care of, Simon adds. “Now the challenge is running a business, running it profitably and unselfishly. What I do now is best for the company and best for the shareholders.”

Today, RSI sales are over $100 million and customers include Home Depot and almost all other major home supply centers. Simon is currently looking to expand the company by acquisition. “We are seriously looking at several acquisitions and if some them come to fruition, then we might be an IPO candidate down the road.”

There are, of course, some downsides to the private recap. An impatient partner can lead to poor decision making, while an aggressive partner could force the hand of the original owner.

But on the flip side, a private recap can offer entrepreneurs positives, such as: liquidity for estate planning or asset diversification purposes; partial liquidity of manager-owners; the ability to buy out a partner or competitor without over-leveraging the company; and a financial alternative to an IPO. It can also help you find a financial partner in consideration of a future IPO.

With a private recap, entrepreneurs can get cash for the company and still retain an ownership position, says Megrue. “They can have their cake and eat it too.”

Steve Bergsman is a Mesa, AZ-based freelance business writer who has written about corporate finance for Reuters, Barron’s, Global Finance and Corporate Finance.

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