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Leveraged Recapitalization

Tapping into Your Equity: Enhancing Long-term Shareholder Value

The vast majority of most entrepreneurs’ personal net worth is often "trapped" in the business they own. A leveraged recapitalization, or recap, enables the business owner to experience a liquidity event by “taking chips off the table” and diversifying their estate without selling the company.

“Aside from a sale of the business, other avenues exist to access liquidity for those desiring to retain majority control and continued employment,” says Brian Dragon, a senior managing director of FINNEA Group, a boutique investment banking firm located in Birmingham, Mich.  “One method for unlocking equity value is a financial mechanism known as a leveraged recap, a strategy whereby the company raises additional capital and distributes the proceeds to the shareholders for their personal account.” 

These solutions are quite viable under the right set of circumstances. However, Dragon cautions, “recapitalizing the balance sheet is situation specific and not appropriate for all businesses. The optimal time to recap depends on a confluence of factors, including the owners’ liquidity requirements, the lending environment, and key characteristics of the business.”

Select attributes of an ideal recapitalization candidate include:

•   Strong free cash flow: Measured as earnings before interest, taxes, depreciation, and amortization (EBITDA) minus cash taxes minus maintenance capital expenditures. This metric is critical to ensure sufficient ability to remit interest and principal payments on the newly placed debt; growth capex may also need to be factored in.
•    Customer diversification: The ability to service debt will be greatly impaired given the loss of a customer that constitutes a significant portion of annual revenue.
•    Experienced financial team: Higher debt levels necessitate greater financial discipline and reporting requirements, therefore requiring personnel with significant financial acumen.
•    Conservative balance sheet: The magnitude of incremental debt a business can support is a direct function of the current balance sheet. That said, in an instance where one intends to deploy the additional capital for growth rather than as a distribution, lenders might look at “pro forma” financial statements that reflect the impact of the prospective investment(s).


This transaction involves securing additional debt and then declaring a special dividend with the proceeds. For example (see Exhibit A), consider a company that generates annual EBITDA of $8 million with $8 million of outstanding debt. As the amount of debt equals the amount of EBITDA, this business is currently levered at 1.0x senior debt/EBITDA. Assume the incumbent senior lender analyzes the financial statements, company prospects, and collateral position and then communicates comfort extending credit up to 2.0x EBITDA for purposes of a shareholder distribution. This equates to incremental and total senior debt of $8 million and $16 million, respectively. Of note, the senior lender will analyze the company’s debt capacity in conjunction with a shareholder distribution to ensure sufficient “dry powder” exists to continue financing its ongoing needs. 

Depending on its cash flow profile, the business might also support a tranche of subordinated, or mezzanine, debt from a junior capital provider (not a traditional commercial bank). This class of capital is generally unsecured and subordinated to its senior indebtedness. That means such financing is more expensive than traditional senior debt; however, these junior capital institutions provide additional financing that is otherwise difficult to obtain in the traditional senior debt market. 

Subordinated notes typically do not require principal payments, mature at least five years from the date of issuance, may include nominal warrants, and do not require personal guarantees. For illustrative purposes, we assume another “turn and a half” of subordinated leverage (i.e., 1.50x subordinated debt/EBITDA, or $12 million). 

In the following scenario, the company would incur $20 million of additional debt and distribute $20 million as shareholder proceeds. 

Exhibit A



($ thousands)

Status Quo









Senior Debt



Subordinated Debt



Total Debt




Distributable Proceeds

              $ - 



Senior Debt/EBITDA



Subordinated Debt/EBITDA

- x


Total Debt/EBITDA



“Given the magnitude of leverage, speed of repayment, financial health of the business, and the broader lending/macroeconomic environment, it is not uncommon to repeat this process multiple times over the span of many years,” says Adam Wirick, a vice president at FINNEA Group.

To facilitate a more sizable distribution, the junior capital provider could also purchase a minority stake in the business through a preferred equity instrument. Such a transaction could have a profoundly favorable impact on an owner’s personal bank account and simultaneously provide growth capacity as such junior capital providers seek to deploy more mezzanine financing when opportunities arise. But there is a tradeoff; typical minority investors structure their investment to include equity ownership, in an amount that is commensurate with the size of the recapitalization.

While the business owner retains majority control, they have effectively added a new partner.

“Minority shareholder investors entrust day-to-day operations to the existing management team, but reserve corporate governance rights regarding certain ‘high level’ business decisions such as future distributions and M&A transactions, among others,” Wirick adds. “Our experience has been that owners who recapitalize with a junior capital provider are often appreciative of the strategic and financial resources the investor brings to the table.”
To learn more about Comerica Bank’s network of middle market-focused M&A and junior capital advisory firms, contact your relationship manager at Comerica Bank.

Comerica Bank. Member FDIC. Equal Opportunity Lender.

This material has been distributed for general educational/informational purposes only, and should not be considered as accounting, tax or legal advice or recommendations by Comerica Bank, its affiliates or subsidiaries.

Interest Rate Risk

Minimizing Risk As Interest Rates Rise: Some Tools of the Risk Management Trade

No one has an economic crystal ball, but it doesn’t require one to see that U.S. economic strength is increasing and long-term interest rates have moved up. After years of low market rates in response to protracted financial crises and political uncertainty, the interest rate market has begun to reflect the potential for short-term interest rate increases led by the Federal Reserve.

Now could be a good time to lock in low fixed rates as protection from higher rates down the road. With that potentially happening, which tools are best — and how do they work?

Make a Swap

Swaps allow companies to restructure the interest rate profile of their debt without restructuring their loan. In implementing a swap, floating interest payments are exchanged for fixed payments at an agreed-upon rate for the duration of the agreement.

“If a customer wants to take advantage of today’s lowest rates, they go variable,” says Brian Petrak, senior vice president, Global Capital Markets at Comerica. “If they prefer to pay a higher rate in exchange for protection from increasing interest rates, a swap can be a smart move.”

He cites an example of a company with a seven-year variable-rate property loan based on LIBOR (London Interbank Offered Rate). The company asked the bank about hedging options.

“An environment in which short-term rates are rising and long-term rates are flattening is ideal for a swap, and that’s what we proposed,” recalls Petrak. The customer swapped the variable rate for a fixed rate of 5 percent for five years, knowing they would own the property for that long. After five years, they can do another swap or allow the rate to go back to the prevailing variable rate.

Another company holding $4 million in variable-rate loans with Comerica and another financial institution was concerned about rising rates and asked Comerica for some options. The other institution didn’t offer favorable fixed-term options, so Comerica helped them hedge half of their position by structuring three swaps totaling $4.5 million (each with a different fixed rate and term).

“Hedging half of their floating rate debt allows a business to see an upside whether rates go up or stay down,” says Michael D. Burck, vice president, Global Capital Markets at Comerica. “If rates go up, they’ll be happy that half of their debt has a fixed rate. And if short-term floating rates stay low, part of their loan portfolio will benefit from remaining at the floating rate. This way a company doesn’t have to be as concerned with making a wrong decision.”

Capitalize on a Cap

Caps are also useful now as insurance against rising rates, especially if you think rates will stay low for a while longer and don’t want to fix your rate with a swap. Borrowing at a floating rate while simultaneously buying an interest rate cap provides protection from higher rates while maintaining the benefit of current low rates. You designate the highest interest rate to be paid over the loan period.

In another example, a company wanted real estate financing that would provide interest rate protection with no potential prepayment premium. A cap provides that approach. As opposed to a conventional fixed rate loan, the customer gets the benefit of the current lower variable interest rate market with a limit on how high their rate can move. The customer bought a cap at 4.75 percent on one month LIBOR for five years. Their loan balance will be low enough in the last two years to enable them to pay off the loan or not be significantly affected by interest rate movement.

Another potential benefit to a cap is if you pay off the loan, you no longer need the cap and there is no cost to terminate it. There may also be some residual market value to the cap, for which Comerica would offer a cash payment.

Forget Floors — and Use Collars with Caution

An interest rate collar involves buying a cap while simultaneously selling a floor to offset part or all of the cap cost. If the values of the cap and floor are the same at inception, that creates a no-cost collar because their respective costs offset each other. Collars typically make sense when short- and long-term rates are very close to each other and the yield curve is flat, which isn’t the case today. However, floors are not a beneficial option in the current interest rate climate, since short-term rates are so low.

Hedge Your Bets

One final example: companies that may not be able to raise revenues easily if rates rise should look at hedging. For instance, if a 2 percent rise in interest rates wouldn’t affect your business, but a 4 percent rise would be a problem, you could buy a cap or fix a portion of the debt with a swap so you’re not totally exposed.

Let Us Help You Put the Tools to Work

These are all relatively simple examples of what can be very complex finance structures. Your use of interest rate risk management tools depends on many factors, such as expectations for future cash flow, debt paydown, and possible new financing needs. That said, any business with exposure to floating rate debt, and especially companies needing to closely manage their cash flow, can benefit from these tools.

Comerica can help you evaluate your interest rate risk and spell out your options. You’ll also find that we’re flexible about how we apply these interest rate-hedging products. For instance, you might be able to cap or swap a portion (minimum of $1 million) or term of your loan for up to 10 years. We can customize your solution based on your financing needs. Businesses are always working to manage interest rate risk, and Comerica’s Global Capital Markets Group finds creative new ways to help. For more information, please contact your Relationship Manager.

Interest Rate Risk Management Tools

Interest Rate Swap

  • A contract to exchange interest payments, which effectively converts a floating rate loan to a fixed-rate loan
  • No up-front fee
  • Less expensive to terminate than a traditional fixed-rate loan (saves margin component of prepayment premium)
  • Separate transaction from the loan
  • Potential market value gain if rates rise (cash value when terminated)
Interest Rate Cap
  • Customer buys interest rate protection from rising rates by setting a limit to how high they want their rate to go
  • Up-front fee
  • Provides a maximum interest rate while allowing customer to enjoy current low rates
  • Separate transaction from the loan
  • No payment required to get out of a cap
  • Potential market value gain if rates rise (cash value when terminated)

Interest Rate Collar

  • Combines the purchase of a cap and the sale of a floor
  • Can create a “no-cost collar,” which eliminates the up-front fee
  • Separate transaction from the loan
  • Provides a maximum and minimum interest rate range rather than a set fixed rate 

Comerica Bank. Member FDIC. Equal Opportunity Lender.

This material has been distributed for general educational/informational purposes only, and should not be considered as accounting, tax or legal advice or recommendations by Comerica Bank, its affiliates or subsidiaries.

Payment Trends & Security

High-tech Solutions to Payment Challenges: The ABCs of Omnicommerce, Fraud Liability Shift, Lowering Fees

The explosion in new business technologies has inescapable ramifications for the way middle market companies receive customer payments, secure their data, and control costs. In fact, it’s forcing once-common business tools to go the way of carbon paper and typewriters on the trash heap of obsolescence. Here’s a look at some of the changes and how they can affect — and ultimately benefit — your business.

Omnicommerce may sound like just another B-school buzzword, but it’s a reality today as customers pay for products and services not with cash or cards, but with their mobile devices linked to payment services like Google WalletTM 1 or Apple PayTM 2.  Using Near Field Communication (NFC) technology based on electromagnetic radio signals, these systems allow customers to securely store account information on their devices and wirelessly pay at the point of sale. Merchants and organizations that accept credit, debit, or corporate cards must upgrade to NFC-compatible terminals.

Global information firm IHS predicts worldwide shipments of cell phones equipped with NFC technology will surge to 1.2 billion units by 2018. Mobile payments at Whole Foods Market have jumped by more than 400 percent since Apple Pay was launched in October 2014, according to Macworld.com.

“Businesses must recognize the growth of nontraditional payment options available to buyers today, whether it’s retail or B2B,” says Chris Healy, vice president, Comerica Merchant Services. “They increasingly need to invest to meet buyers at the point where they want to pay if they want to see their business continue to grow.”

Organizations that accept, transmit, or store cardholder data are required to comply with rules set by the Payment Card Industry Data Security Standard (PCI DSS) to ensure the information remains secure. This means:
    1) a secure network with robust firewalls must be maintained;
    2) cardholder information such as date of birth, mother’s maiden name, and Social Security number must be protected;
    3) anti-virus, anti-spyware, and anti-malware software must be frequently updated;
    4) only cardholder information required to carry out a transaction should be requested;
    5) networks must be regularly monitored and tested for security, and
    6) formal information security policies must be defined, maintained, and followed at all times.

In October 2015, the EuroPay/MasterCard®/Visa® (EMV®) Compliance Mandate will take effect in the U.S.3 Its intent is to reduce payment card fraud following a model similar to those used in other countries that observe the EMV Mandate. Instead of using the familiar magnetic strip to store user data, EMV payment cards feature cryptographic algorithms embedded in a chip to “talk” to EMV-compliant terminals and bank processing systems. Financial institutions and merchants using non-EMV-compliant systems and accepting transactions made with EMV-compliant cards will see the liability for counterfeit transactions fall on them.

That’s not to say transactions using the former swipe and sign technology will cease. However, the liability shift provision of the EMV Mandate aims to discourage that.

“If either the merchant or the customer uses EMV technology and the other party does not, the party that uses EMV will win any fraud dispute over that transaction,” Healy says. “It’s an incentive for businesses to adopt the technology.”

Data and Reporting
The amount of data — or “interchange qualifications” — that a payment card processor requires for a transaction can represent up to 95 percent of the cost of that transaction. In many B2B situations, middle market companies can realize lower transaction fees by inputting additional information like item quantities and the amount of tax. But these savings can be erased if insufficient data is entered because of clerical error or when “timely settlement” of a transaction is not achieved.  

“Our team of strategic vendors can provide online tools that slice data by card type, specific clerk, or location,” Healy says. “These tools allow companies to detect a deterioration in interchange qualification and to adjust business processes to qualify for the lowest fees.” 

Healy says these same online tools can be used to manage disputes between cardholders and businesses. “In the past, the business would have to get receipts to prove they did the transaction correctly and fax those receipts into the processor,” he says. “That can all be done online now. With a thorough understanding of our customers and their payment needs, Comerica Merchant Services can recommend appropriate solutions.” 

To discuss how these and other technologies affect your business, contact your middle market banker, Comerica Merchant Services representative or Chris Healy at 714.424.3856 or chealy@comerica.com.

For more information, refer to these online resources:
•    Frequently Asked Questions: http://merchant.comerica.com/Resources/EMV-FAQ-for-Merchants
•    The Smart Card Alliance: smartcardalliance.org

1 © 2015 Google Inc. All rights reserved. Google Wallet is a trademark of Google Inc.
2 Apple Pay is a registered trademark of Apple Inc.
3 EMV is a registered trademark in the U.S. and other countries, and is an unregistered trademark in other countries, owned by EMVCo. EMV (Europay, Mastercard®, and Visa®) chip technology will be required in the United States by October 2015 to better protect merchants and consumers from counterfeit fraud. MasterCard is a registered trademark of MasterCard Worldwide or its subsidiaries in the United States. Visa is a registered trademark of Visa International Service Association and others in the United States and other countries.

Comerica Bank. Member FDIC. Equal Opportunity Lender.

This material has been distributed for general educational/informational purposes only, and should not be considered as accounting, tax or legal advice or recommendations by Comerica Bank, its affiliates or subsidiaries.