Debt recapitalization as a buy-in to a business

February 26, 2025

by a searcher from University of Minnesota - Twin Cities Campus in Marysville, WA, USA

Hi everyone!

I've been in conversations with a seller since September, and he's wanting a minority or majority investment from me/my search fund (long story short, I'm still exploring a more traditional acquisition, but I would love to discuss the following option, too, since there'd be no other equity investors to share the cap table with). Because of the enterprise value of the deal, my personal balance sheet is not nearly large enough for a direct investment to earn me any sort of meaningful equity stake in the business. I have term sheets from non-PG commercial lenders whose debt offers would give me the capital to acquire approximately 30% of the business, which would be an awesome size of equity stake for me to have.

That being said, the seller grew up in a culture where debt was very much frowned upon, so he's hesitant to accept debt onto the business (even though it wouldn't be tied to him personally and would have a strong DSCR as not to constrain cash flow). My question is twofold:
- First, does anyone have any commentary or third-party resources that discuss the benefits of a debt recapitalization that I could share with the seller?
- Second (and this is a huge ask), would anyone who has experienced a debt recapitalization and/or knows a lot about them be willing to speak with the seller and walk him through why this is a good option?

Not only would this get me, my time, and my connections into his business in a large way, but it would also open up lending relationships that could also be used for additional acquisitions down the line, which is a big goal of his. Thanks in advance for any constructive thoughts you may have!

Reply by a searcher
from University of Pennsylvania in Seattle, WA, USA

From your post it is not clear but I would triple check your math/understanding with the lender. Typically lenders will be lending to a business, with the collateral of the entire business pledged against the loan. If that is the case, the 30% loan value is not really your investment or ownership in the business if it is underwritten by the company. If the lender is lending to you personally and you are using it as an investment in the company, that is a different story. The way the prompt is written sounds like the owner will do a leveraged recap and you want to treat it as your investment.

If the business is $10m EV and takes a $3m (30% loan), the owner will get a $3m check, the business will have a $3m loan, and the remaining equity will be worth $7m. You have now lowered the equity value by 30% so your cash investment buys you a bigger portion of the equity but the debt is not your investment in that scenario. Asking a different way, is your DSCR calculated using the entire business cashflow or only the 30% you calculate you will own after the transaction?

The reason why an LBO works is that the entire company is being purchased with debt so the seller does not have any equity left in the business and the entirety of the debt burden of the business is being used to buy the equity. I feel like I may be missing something from your prompt but it caught my eye as being a potential major issue.

Reply by a searcher
from University of Minnesota in Marysville, WA, USA

You're not wrong in your assessment! The term sheets I have do require the business pledged as collateral, so maybe what I'm trying to do here isn't possible/intelligent. One note about this scenario is that the seller wants to retain equity, anywhere from 25-40%. I don't know if that changes your thoughts on the scenario, and I'm open to your suggestions about ways to get equity in this business without having the personal balance sheet to buy in at a meaningful level and without an equity investor (which is something we're trying to find but have yet to).

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