LEVERAGED RECAPITALIZATION CAN BE A POWERFUL FINANCING TOOL -- From the perspective of a borrower, there couldn't be a better time to be in the market for capital. A leveraged recapitalization can assist companies and their owners in meeting their business objectives.

In the article below, "Executing a Privately-Held Business Succession Plan with a Leveraged Recapitalization,” Ira Kreft, Executive Vice President and Group Manager for the Midwest Region of Bank of America Business Capital, tracks a number of emerging trends, including the migration of borrowers to asset-based structures and a growing use of second lien debt in lieu of traditional mezzanine financing. The net result for middle-market borrowers is a wider array of financing alternatives. Based in Chicago, Mr. Kreft’s group is responsible for business development efforts within a 14-state area in the Midwest region of the United States and the Canadian provinces of Ontario and Quebec.

Please note that FOCUS has direct access to recapitalization sub debt financing, in amounts ranging from $2-50 million. For detailed information on lending criteria and terms for amounts ranging from $2-10 million, please review the extensive information on our website about FOCUS Mezzanine. Just click on the “FOCUS FUNDS” heading on the red navigation bar of our website. For larger amounts, deal particulars will dictate terms. In any event, please contact us to discuss your recapitalization financing needs.

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Active FOCUS Deals

With over 24 years of experience across many verticals, FOCUS currently has over 30 active transaction engagements in its four offices in Atlanta, Chicago, San Francisco and Washington, DC in the following specific business sectors:

• Business Services
• Call Center Software
• Consulting
• Electrical Tranmission Equipment
• Food and Beverage
• Government Contracting (multiple assignments)
• Healthcare Business Services
• Information Management
• IT Outsourcing (multiple assignments)
• IT Services (multiple assignments)
• Library Services
• Maritime Shipping
• Media
• Medical Devices
• Security
• Software
• Transaction Management Services
• Truck/Transport Capital Equipment

Our transaction process provides us with up-to-the-minute market knowledge in these sectors. Are any of them of corporate development interest to you? Give us a call or drop us a note.

Inquiries should be addressed via e-mail to info@focusbankers.com, by telephone to 202-785-1965 or by fax to 202-785-9413.

Strategic Defense Alliance Corporation Has Acquired Computer Networks and Software

FOCUS initiated the transaction, acted as a financial advisor to, and assisted with the negotiations as the representative of Computer Networks and Software, Inc. (CNS). CNS provides technology and telecommunication related services to Federal government customers and reported approximately $8M in revenue during 2005. Strategic Defense Alliance Corporation (SDAC) is a newly organized public company with a purpose to acquire companies in the Federal government space. SDAC is headed by Paul B. Silverman and is funded by Liberty Capital and Barron Capital Partners. For more details on this transaction, please click on this link: www.focusbankers.com/tombstones/deal_CNS.asp. FOCUS currently is very active in the government contracting space with multiple buy-side and sell-side engagements.

Executing a Privately-Held Business Succession Plan with a Leveraged Recapitalization

By Ira Kreft, Executive Vice President, Group Manager, Bank of America Business Capital

With the rise in valuations for many middle-market companies in recent years, owners of privately-held businesses are once again confronting the decision of whether or not to sell. Owners who are not ready to retire completely, but want to unlock the value of the equity they've built in their business have alternatives. One option is to transition ownership of the business to a partner or family member. For these business owners, a leveraged recapitalization can be a valuable financial tool for succession planning.

To Sell or Not To Sell

Private equity firms are flush with cash and aggressively pursuing new platform acquisitions and add-on acquisitions for existing portfolio companies. In addition, strategic buyers are returning to the mix, which further increases the competition for quality transactions.

With purchase price multiples for private equity sponsor-backed leveraged buyouts of companies with EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of $50 million or less having risen from 5.9 times EBITDA in 2001 to 7.9 times in the first half of 2005, many business owners would do well to consider selling. However, not all companies command these high valuations.

For more marginal companies and those subject to earnings compression because of raw material price increases and an inability to pass those increases through to the customer, the market has been more discriminating and has therefore ascribed lower valuations. In addition, for many privately-held businesses there may be a strong preference to keep ownership in the family or transition to a business partner.

Succession Planning

The desire to retain ownership of a business has been supported by a rising incidence of formal business succession planning by owners and their companies to guide the transition of ownership from one generation to the next. The leveraged recapitalization can be an important financial tool in business succession plans.

This involves reconfiguration of a company's capital structure consistent with the plans and goals of both the owners and the company. It enables business owners to gain some liquidity for their investment, retain a significant ownership (and thereby participate in the company's upside potential), and continue to operate the business with considerable autonomy.

A leveraged recapitalization can take the form of a buyout of other owners or the payment of a one-time distribution to provide diversity and/or liquidity for their estates. In some cases, the need for a leveraged recapitalization of the business can be precipitated by a fundamental disagreement among the owners of a business regarding its future or the desire of one of the owners to pursue interests outside the business.

Capital Structure Considerations

Regardless of the circumstances for a recapitalization, a proper capital structure for the transaction is critical. At times, there is a desire by owners to structure a recapitalization to gain liquidity while minimizing or eliminating any loss of equity. While an all senior debt recapitalization may be feasible in some cases, it is critical to ensure that the post-recapitalization capital structure leaves the company in a financial position to conduct its operations with a satisfactory margin for error.

From a senior lender's perspective, the decisions involved in determining the amount of senior debt that can be provided are similar to any other leveraged transaction. An extremely important concern for the lender is ensuring that the owners have a sufficient level of commitment to the business following a recapitalization. If the owners are being paid a substantial distribution as part of the recapitalization, a key question for the lender or junior capital investor is whether the owners have a sufficient continued economic need for the business to move forward.

This is particularly critical if the business runs into difficulty and the owner's attention is needed. If there is no outside capital investor in the transaction, or if the business owner's commitment is questionable because of the magnitude of the proposed distribution, the senior lender may reduce the amount of senior debt it will provide and/or seek some form of support from the business owner, such as a personal guaranty.

Outside Investors

In some cases, in order to support the liquidity and growth needs of the business and to complete the recapitalization, it may be necessary to bring in an outside financial partner. If additional capital beyond senior debt is needed, there is a significant amount available in today's market to round out the company's capital structure. Because of the large amount of buyout funds raised in recent years, the competition for quality companies has increased significantly.

A number of mezzanine and equity investors have decided to pursue investments in leveraged recapitalizations and growth situations to seek more reasonable leverage and investment return opportunities. These investors are generally looking for companies with above average revenue and earnings growth, a significant market share or niche position, experienced management teams, and excellent historical and projected performance.

While some players will accept a minority position in a company, most of them will allow the owner to maintain day-to-day operating control. However, the private equity sponsor may insist on having voting control or shareholder agreements that enable them to take control of the company in a deteriorating situation.

Debt Considerations

From the perspective of a borrower, there couldn't be a better time to be in the market for capital. For senior debt, covenants have loosened, maturities have increased and lenders are competing on price. A number of trends have emerged in this credit cycle, including the migration of larger and better quality borrowers to asset-based structures and a growing use of second lien debt in lieu of traditional mezzanine financing. The net result for middle-market borrowers is a wider array of financing alternatives and the ability to create an optimal, total capital structure.

While asset-based lending can require more reporting and monitoring, many companies have embraced asset-based lending as a long-term financing solution for their company because of competitive pricing, flexibility, and covenant-light structures. Borrowers are often happy to avoid quarter-to-quarter covenant anxiety.

This is particularly important for a company that is undergoing a recapitalization and taking on additional leverage. In addition, because of the underlying asset coverage, it may be possible to structure the leveraged recapitalization with an initial distribution to the shareholders as well as a percentage of excess cash flow on an annual basis thereafter that will maximize the cash flow to the owners.

Recap of a Recapitalization

The following is a hypothetical example of a leveraged recapitalization:

Background— A privately-held manufacturer of plastic products for industrial applications is owned by three family members. Two of the family members, who are not active in the business and collectively own 40 percent of the stock, want to cash out of their ownership position. A leveraged recapitalization will provide flexibility for ongoing operations and leave the company with at least $7.5 million of undrawn liquidity.

Financial Overview— The company has $200 million in revenues, EBITDA of $24 million, and approximately $10 million of outstanding debt. The company operates in some cyclical industries and can be negatively affected by commodity price fluctuations. A valuation of the business indicated an enterprise value of $140 million.

Financing Solution— To support the company's growth objectives and provide ample liquidity, and a manageable level of debt service, the leveraged recapitalization includes both senior and junior debt. The senior component consists of a $28 million revolving credit facility based on accounts receivable and inventory as well as a $25 million term loan amortized over 7 years. To complement the senior debt, the company raises $20 million of mezzanine financing. Post-recapitalization, the company will have a total debt-to-EBITDA ratio of 2.8 times and Fixed Charge Coverage of 1.5 times (EBITDA - CapEx - Cash Taxes/Principal Payments + Interest).

Post Recapitalization

A leveraged recapitalization can be a powerful financing tool that can assist companies and their owners in meeting their business objectives. Following a leveraged recapitalization, company management tends to become more focused on the efficiency and effectiveness of its operations, resulting in improved operating performance and working capital management. Today's market offers an ample supply of capital to consummate transactions; however, it is important to select the right financial partners and the appropriate capital structure for the long term.

This article is reprinted with permission from the September 2005 issue of CapitalEyes, published by Bank of America Business Capital. More CapitalEyes articles can be found at www.bofabusinesscapital.com.

Crushed by Savings--It’s America’s Other Debt Crisis: Companies Don’t Borrow Enough

In the March 6, 2006 issue of FORTUNE, Geoffrey Colvin sends a provocative message to CEOs. Below are excerpts from his article:

But America has another debt problem that you never hear about: the plight of the under indebted company. Believe it or not, our corporations salt away too much cash and don’t carry enough debt…

Most companies use a combination of debt and equity, and finding the best mix is a deep field of study in which economists have won Nobel Prizes. But it’s crucial to remember a basic point: Debt capital is cheaper than equity capital. The rate of return that equity investors demand is always going to be higher than prevailing bond rates…Considering that the very essence of corporate performance is earning a return on capital that exceeds the cost of capital, corporate America has long been way underleveraged…

The obvious question is why. The answer seems to be that managers like it that way. Low debt gives a company more of a cushion against financial shocks (and makes its stock price less volatile), which reduces stress for the CEO. Most of the time investors would gladly accept the extra volatility accompanying the extra value they get from replacing some equity with debt capital…”

FOCUS Web Watch: SECTORS

A new section has been added to the FOCUS website. In the red navigation bar at the top of the Home Page, third from the left, is a link to the new SECTORS area: http://www.focusbankers.com/sectors/.

FOCUS Partners are experts in a wide variety of business areas, both national and international. The new SECTOR page includes an alphabetical list of sectors FOCUS Partners currently are working with buy- and sell-side corporate clients, private equity groups, holding companies, and early stage venture capital firms.

About FOCUS Enterprises, Inc.

Headquartered in Washington DC, with offices in Atlanta, Chicago, and San Francisco, FOCUS provides a range of investment banking services tailored to the needs of middle market companies. FOCUS specializes in serving businesses with revenue or transaction sizes between $5 million and $300 million, serving entrepreneurs, corporate owners, public companies, private companies or operating units, and various types of investors.

For 24 years, FOCUS has successfully integrated corporate development consulting and transactional expertise with its extensive research capability. The firm has long standing experience in completing mergers, acquisitions, divestitures, capital formation assignments, corporate development consulting projects, and financial advisory engagements.

Over twenty FOCUS Partners and Principals provide over two centuries of C-level operating experience in a variety of industries.

Please contact us at: info@focusbankers.com