leave distressed PE funds? It does not
leave them in a favorable position.
Companies that do not show these
strengths may still be candidates for
alternative exits, including emerging
growth company initial public offerings
(IPOs), dividend recapitalizations,
and bankruptcy recapitalizations.
Recapitalization of Distressed
Investments Using Bankruptcy.
For many managers, contributing
more capital to an underwater
investment seems like throwing
good money after bad. But a savvy
manager may be able to recapitalize
a distressed portfolio company using
the bankruptcy process—wiping
out debt and unfavorable contracts
and leases in Chapter 11—all for a
modest additional investment.
Sheldon L. Stone is a partner with Amherst Partners
LLC and provides financial and strategic solutions in
the area of corporate revitalization to companies in a
range of industries. He represents debtors, creditors,
and other parties in interest and has extensive
experience in vendor and customer negotiations,
accommodation agreements, debt restructurings,
and recapitalizations. Stone has served as interim
CEO, CRO, and court-appointed receiver. He holds
bachelor’s degrees in business administration
and psychology, and a master’s degree in
organizational behavior, both from Western Michigan
University, and an MBA from the McDonough
School of Business at Georgetown University.
additional minimal amount of capital
to reinvigorate Fluid Routing so that
a mere three years later it would
net 7.5x its total invested capital.
Emerging Growth Company IPOs.
Despite the Facebook fiasco and an
often-choppy IPO market, an IPO
still may be a viable exit for middle
market companies. Recently, the
JOBS Act created a new class of
public companies, “emerging growth
companies,” to encourage IPOs from
domestic and foreign private issuers
with gross revenue of less than
$1 billion. Regulatory requirements
are minimized for an emerging
growth companies going public.
Sun Capital recently recapitalized
Friendly’s, an ice cream parlor chain
and one of its portfolio companies,
by purchasing the company out of
bankruptcy through a credit bid in a §363
sale. The firm thus assumed two roles
with Friendly’s—owner and creditor.
Prior to Friendly’s bankruptcy, Sun
loaned the chain $75 million in debtor-in-possession (DIP) financing, which it
then used to credit bid and purchase the
company in the 363 sale. Although Sun
Capital’s prebankruptcy equity was wiped
out, it retained control of the company
and used the bankruptcy process to shed
other debt and unfavorable contracts.
Recent examples of successful
emerging growth company IPOs
included the $260.4 million offering
by Palo Alto Networks, backed by
Globespan, Greylock Partners, and
Sequoia Capital; the $91 million
offering by Kayak Software, backed
by Accel Partners, General Catalyst
Partners, Oak Investment Partners, and
Sequoia Capital; and the $163.4 million
offering by clothing retailer Five Below,
backed by Advent International.
Many emerging growth companies
continue to use this IPO fast-track,
such as Trulia, an online real estate site
backed by Accel Partners and Sequoia
Capital, which filed confidentially as an
emerging growth company at the end of
September 2012. However, not all recent
potential IPOs have followed through.
For example, LegalZoom delayed its IPO
in August, citing unfavorable market
conditions, while Fender withdrew
its offer in July for the same reason.
Recap of Dividends. Dividend
recapitalization involves a company
taking on new debt to pay a dividend
to its sponsors, which can then return
capital to their limited partners while
maintaining ownership of the company.
However, dividend recapitalization is
controversial because it allows investors
to profit on the return while shackling
companies with additional debt.
The firm has a good record of
recapitalizing distressed portfolio
companies as a DIP lender. It recently
completed a successful exit from
Fluid Routing Systems, which it
had recapitalized in bankruptcy in
2009. Sun Capital was able to use an
Roark Capital Group has performed
15 dividend recapitalizations in the
past year, with returns of more than
$346 million. Accordingly, it is evident
that while dividend recapitalization
is a controversial step, especially
with distressed investments, it is also
an option that results in investors
receiving a partial return of capital
from certain portfolio companies.
Also, if the company continues to
grow, the sponsor may achieve a
second liquidity event in the future.
Regardless of choices made to hold
current investments or divest, there are
challenges ahead for both distressed
and traditional PE funds. It’s safe to
assume that the U.S. economy is
not going to accelerate much faster
than its current rate of growth for
some time, which means cash will
continue to sit on the sidelines. J