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  • Factors Influencing Financial Deal Structure

    Oct 16, 2014

    The sale of a privately held company is a sophisticated transaction on multiple levels. One unique component of a business sale is that the successful transition of ownership of a company requires a collaborative period of post transaction interaction between the buyer & seller. This requirement does not exist in very many types of transactions. A party can purchase a multi-million dollar residence, a commercial property, or a yacht and never meet the prior owner. However, to successfully transition ownership of a business, a strategy needs to be developed between the buyer & seller to smoothly transition customers, suppliers, employees, and systems to minimize the impact of the sale on the business.

    The most confrontational negotiation in the sale of a business is traditionally the one conducted over the price & financial terms of sale. This is one of the reasons that a professional mergers & acquisitions firm will strive to bring a business on the market at an appropriate value that can be justified to a buyer, their professional advisers, and the lending community. The financial term structure negotiated between the parties is traditionally influenced by the following three factors.

    1. Risk Allocation
    2. Source of Acquisition Capital
    3. Tax Implications

    It is common for the seller of a privately held company to desire 100% cash for their company. The motivation behind this desire is to minimize post transaction risk. However, an 100% cash transaction is often not in the best interest of a buyer as it does not allocate any risk to the seller in the event an undisclosed liability (tax, litigation, etc.) is identified post transaction, seller obligations in terms of transition training/consulting or non competition agreements are not met, or customers or key employees are lost post sale for reasons that were not disclosed or factored into the valuation of the company. Financial terms such as an escrow holdback, seller promissory note, or variable financial component (earn-out) are often employed to balance risk between the parties through a transition of ownership. The business banking community has also identified the need for an appropriate risk allocation between the buyer & seller and often will ask for a seller promissory note of 10% or more of the transaction value to be included in the financial terms of a transaction to address unforeseen post transaction liabilities.

    Acquisition capital traditionally comes from one of four sources in the purchase of a privately held company. The first source of capital is the assets of the buyer. This is the easiest source of capital to access with the fewest governing restrictions. The second source is the seller of the business. This source of acquisition capital can come in the form of a promissory note or compensation contingent on the future performance of the company. The third source of capital is the lending community. Currently, the lending community is an active participant in transactions and favorable terms are available based on the low interest rates currently available from the financial community. The final source of capital is the private lending community. This community is presently very active in the mergers & acquisitions market given the improving health of the economy and the low returns on investment currently available on idle cash in the bond & savings market.

    The final factor that will impact the financial term structure of a transaction involving a privately held company is the tax implications of the sale for the parties. As primarily a seller representation company at IBA, we educate our clients on the value of a properly structured transaction for tax purposes early in the sale process. It is our opinion that the net proceeds from a sale are much more important to a seller than the gross proceeds. An improperly structured transaction can result in a 10% or more loss of proceeds by the seller due to taxes at time of sale. A buyer in a transaction should be cognizant of the acquisition related taxes that result from the transaction and the depreciation & amortization schedules or basis established by the transaction.

    The sophisticated process involved in selling a privately held company or family owned business requires knowledge, experience, and strong negotiation/facilitation skill set. The financial term deal structure is a foundation component of a properly structured “win-win” transaction. Similar to construction, if it is not properly built with the right mix of components, future issues can develop that are detrimental to the success or financial remuneration of the parties.

    IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, and mergers & acquisitions community on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation in terms of successfully negotiating transactions that are “win-win” in an environment of full disclosure between the parties.

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