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Message
Business Buyout Offer
Posted on 2/17/16 at 4:53 pm
Posted on 2/17/16 at 4:53 pm
A friend of mine is selling his business. He has two offers. Which is better?
1)
5 million upfront
$120k/yr salary to stay on for 5 yrs
5 million payment in 5 years (exact amount tied to profits)
2)
3 million up front
$120k/yr for 3 years
7,000,000 owner financed at 7.5% APR over 20 years
1)
5 million upfront
$120k/yr salary to stay on for 5 yrs
5 million payment in 5 years (exact amount tied to profits)
2)
3 million up front
$120k/yr for 3 years
7,000,000 owner financed at 7.5% APR over 20 years
5
Posted on 2/17/16 at 5:01 pm to Ronnie
Without any more information, I'd choose #1. Because I don't know if the current owner is selling to someone involved in the business already. I don't know if he's going to stay on to retain key sources of revenue and provide/share his intellectual property and experience. And not knowing this, to accept the financing over 20 years seems risky. He is presumably selling not only for money, but he wants out. If it goes south, and he has a 20 note, I'm not sure that works well.
That's some of the stuff I'd need to know before even considering the financial aspect. But if the buyer is able to come up with $3-$5MM upfront, that's a good sig. But it brings up another question, is he taking on debt, and where is the debt encumbered to?
That's some of the stuff I'd need to know before even considering the financial aspect. But if the buyer is able to come up with $3-$5MM upfront, that's a good sig. But it brings up another question, is he taking on debt, and where is the debt encumbered to?
This post was edited on 2/17/16 at 5:03 pm
Posted on 2/17/16 at 5:13 pm to Iowa Golfer
Buyer 1 is an outsider
Buyer 2 is an employee and has over 10 years as operation mgr at this company
Owner is staying on 5 years in offer 1 and 3 in offer 2
Buyer 2 taking on 1 million in debt to bank
Buyer 2 is an employee and has over 10 years as operation mgr at this company
Owner is staying on 5 years in offer 1 and 3 in offer 2
Buyer 2 taking on 1 million in debt to bank
Posted on 2/17/16 at 5:15 pm to Ronnie
The pure math says if he can get more than ~13% on reinvestment for the next 20 years, A is the higher EV. If less, B.
The math most importantly doesn't account for the friend's liquidity preference/estate planning and perhaps more importantly doesn't analyze the particulars of the delayed consideration, namely the creditworthiness/solvency of the suitors. So more relevant is deets on the suitors' profile, which your friend is entitled to, and if either suitor has any apprehension about coughing data up, he knows which one not to pick.
Either is a big mix of post-Closing consideration. A's 5-year delay for 50% of the total consideration tied to profits is a good while. He should consider pushing for a slight $ haircut if he can break that payment up over a few years to derisk it, or demand more upfront. B's got a high rate on a 20-year note and the suitor is already leveraging up on someone who will get credit preference over him.
From afar, frick both of those options as they stand. Your friend needs some degree of formal counsel beyond drive-by TD postings or he's going to get fricked.
The math most importantly doesn't account for the friend's liquidity preference/estate planning and perhaps more importantly doesn't analyze the particulars of the delayed consideration, namely the creditworthiness/solvency of the suitors. So more relevant is deets on the suitors' profile, which your friend is entitled to, and if either suitor has any apprehension about coughing data up, he knows which one not to pick.
Either is a big mix of post-Closing consideration. A's 5-year delay for 50% of the total consideration tied to profits is a good while. He should consider pushing for a slight $ haircut if he can break that payment up over a few years to derisk it, or demand more upfront. B's got a high rate on a 20-year note and the suitor is already leveraging up on someone who will get credit preference over him.
From afar, frick both of those options as they stand. Your friend needs some degree of formal counsel beyond drive-by TD postings or he's going to get fricked.
This post was edited on 2/17/16 at 5:44 pm
Posted on 2/17/16 at 5:17 pm to Ronnie
1) PV=5MM+565k+4.52MM=$10.085MM
2) PV=3MM+3.65MM+346k=$6.996MM
Ok, I used a 2% risk free rate for these PV calculations which is a little bit high. But it looks like option 1 would be worth more. However he needs to account for the risk considering the $5MM is tied to profits over the 5 years period after the sale is made. You can call me out if these numbers are way off.
2) PV=3MM+3.65MM+346k=$6.996MM
Ok, I used a 2% risk free rate for these PV calculations which is a little bit high. But it looks like option 1 would be worth more. However he needs to account for the risk considering the $5MM is tied to profits over the 5 years period after the sale is made. You can call me out if these numbers are way off.
Posted on 2/17/16 at 5:24 pm to Bernie_Madoff
quote:Check the financing amount, logically it can't be less than the principal.
1) PV=5MM+565k+4.52MM=$10.085MM
2) PV=3MM+3.65MM+346k=$6.996MM
Posted on 2/17/16 at 5:50 pm to RemouladeSawce
2) PV=3MM+12.528MM+346k=$15.874MM. I had a negative sign wrong 
quote:
B's got a high rate on a 20-year note and the suitor is already leveraging up on someone who will get credit preference over him.
From afar, frick both of those options as they stand. Your friend needs some degree of formal counsel beyond drive-by TD postings or he's going to get fricked.
This post was edited on 2/17/16 at 5:51 pm
Posted on 2/17/16 at 5:51 pm to Ronnie
There is some tax consequences of this as well.
Looks like in either offer, he's going to have a sale for $10 million, plus either 3 years or 5 years of salary.
In offer 1, what do you mean by exact amount tied to profits?
In general, a seller wants as much guaranteed money as they can get, with as much of that allocated in a way that will result in capital gain.
That is a seriously long payout on the owner finance in option 2.
Looks like in either offer, he's going to have a sale for $10 million, plus either 3 years or 5 years of salary.
In offer 1, what do you mean by exact amount tied to profits?
In general, a seller wants as much guaranteed money as they can get, with as much of that allocated in a way that will result in capital gain.
That is a seriously long payout on the owner finance in option 2.
Posted on 2/17/16 at 7:17 pm to RemouladeSawce
Where would one get this formal council in the Baton Rouge area
Posted on 2/17/16 at 7:42 pm to RemouladeSawce
Rockyn's first post causes some additional concerns before even getting into the finances. Part of the current owner's purchase price is a revenue stream. That's hard to attach even for a bank. If there is real estate involved, I'd say place a lien. In Iowa it's a race to the recorder's office, so he who is recorded first, is first. And I've sold property like this, becuase I know I'm recorded before the bank. I'm not sure how it is wherever this is located. And I'm not sure the current owner has anything to attach for his 20 year loan. Maybe real estate and equipment, and if so, it sounds like the current owner could already be second to the bank.
The owner is loaning money. The buyer always tries to argue this away, but the current owner needs to view this exactly for what it is. Which is a $5MM or $7MM loan. To a couple of guys who apparently borrowed part of the downpayment already.
The financial analysis is meaningless until the current owner determines the character, capital and capacity of the second outside buyer. Presumably he would know at least part of that for the one buyer who is involved in the business.
Finally, Rockyn is absolutely correct about the owner needing to seek counsel. It's a nice sized small business. A good deal of money involved. And I'm assuming again, a fairly significant percentage of the current owner's retirement. The only thing that makes me comfortable about any of this, is that these guys can come up with $3MM to $5MM.
The owner is loaning money. The buyer always tries to argue this away, but the current owner needs to view this exactly for what it is. Which is a $5MM or $7MM loan. To a couple of guys who apparently borrowed part of the downpayment already.
The financial analysis is meaningless until the current owner determines the character, capital and capacity of the second outside buyer. Presumably he would know at least part of that for the one buyer who is involved in the business.
Finally, Rockyn is absolutely correct about the owner needing to seek counsel. It's a nice sized small business. A good deal of money involved. And I'm assuming again, a fairly significant percentage of the current owner's retirement. The only thing that makes me comfortable about any of this, is that these guys can come up with $3MM to $5MM.
This post was edited on 2/17/16 at 7:51 pm
Posted on 2/17/16 at 10:42 pm to Ronnie
I don't know the BR market, but if your friend has whipped up a firm worth 8 figures, he probably knows a few people in commercial banking or wealth advisory that can offer broker recommendations. To be honest he likely doesn't need one based in BR, M&A advisory can be done from anywhere. I wouldn't limit options geographically.
More pointedly than in my prior post, these are not conventional deal structures to say the least. 20 years with chips on the table and only 30% at Closing is comical, assuming option B even has bank signoff to a management buyout (the added financing contingency another Closing risk factor). A 5-year delay to collect the full amount of option A's profit-driven earnout that represents half of the total consideration without anything in between is comical. These do not seem like suitors that have much experience in structuring deals, or they are and are trying to screw your friend. If they're getting unnecessarily creative on structure, I would also be wary as to how they even came to those valuations, which is commonly asked of buyers in competitive auctions when it's time to submit IOIs or LOIs. No disrespect to party B, but his deal structure gives me no confidence that he knows the slightest about valuation (that and the fact that he's in ops). Also, how heavily negotiated have the above terms been? One does not simply accept offers, particularly with the leverage of multiple suitors.
TL;DR if your friend doesn't want to be bent over, he needs more help than TD.
More pointedly than in my prior post, these are not conventional deal structures to say the least. 20 years with chips on the table and only 30% at Closing is comical, assuming option B even has bank signoff to a management buyout (the added financing contingency another Closing risk factor). A 5-year delay to collect the full amount of option A's profit-driven earnout that represents half of the total consideration without anything in between is comical. These do not seem like suitors that have much experience in structuring deals, or they are and are trying to screw your friend. If they're getting unnecessarily creative on structure, I would also be wary as to how they even came to those valuations, which is commonly asked of buyers in competitive auctions when it's time to submit IOIs or LOIs. No disrespect to party B, but his deal structure gives me no confidence that he knows the slightest about valuation (that and the fact that he's in ops). Also, how heavily negotiated have the above terms been? One does not simply accept offers, particularly with the leverage of multiple suitors.
TL;DR if your friend doesn't want to be bent over, he needs more help than TD.
This post was edited on 2/17/16 at 11:09 pm
Posted on 2/17/16 at 11:02 pm to RemouladeSawce
I'm just going to say that structuring a deal this complex is dumb. He should negotiate simpler terms. This much complexity is nonsense.
Posted on 2/17/16 at 11:10 pm to lynxcat
Yeah that's way more succinct. 
It's either amateurs (with whom you don't want to be tied to for 5-20 years) or attempted frickery. I'd guess the former.
It's either amateurs (with whom you don't want to be tied to for 5-20 years) or attempted frickery. I'd guess the former.
This post was edited on 2/17/16 at 11:11 pm
Posted on 2/17/16 at 11:20 pm to RemouladeSawce
I'm astounded by the terms in contracts. I clearly did not belong in law school
Posted on 2/17/16 at 11:26 pm to lynxcat
Option B is nonsensical. No outside investor would provide those terms so the seller shouldn't either. There are very few businesses that support 70% debt with a 20-year repayment term. A 3 to 5-year term with a full cash flow sweep before any dividends are paid out, with a restriction on additional debt maybe. If the business can't (and isn't forced to) de-lever quickly, then no thanks.
Agree with everything Rockyn said too.
Agree with everything Rockyn said too.
This post was edited on 2/17/16 at 11:30 pm
Posted on 2/17/16 at 11:35 pm to lynxcat
If it's heavily blue sky, this kind of sale in my business isn't unheard of. When I bought in, I was offered something like this. Not precisely, but similar insofar as owner financing, and the majority owner wanting to sell to me, etc.
I just went and borrowed from my bank. Essentially I pledged my stock, but it is basically a partially secured signature loan. There are financing options that lend on blue sky, in my case, property/casualty insurance commissions and consultancy fees. But they're going to lend usually a dollar for a dollar, and only as the dollar is generated throughout the year, or years.
Great, except when the going rate of the business is 5X top line. Which the above business could be. Gross revenue X 5. Where most banks won't lend to most buyers at that multiple unless one's signature is extremely strong. Or will lend one year's revenue, and other sources of financing, including some of the options above, are necessary to execute the full asking price.
So I don't think the above is an extremely complicated structure, nor do I think it is unheard of. Again, predicated on the type of business, which I have no idea what it is. But the more I read through the above, the more I suspect there is some high multiple of revenue as an asking price, and no traditional banking collateral, or not enough tangible collateral.
I suggest the guy see his attorney and tax attorney. I'm not a big fan of business brokers. I'm not sure I'd trust their insight into a $10M transaction, tax implications, recourse if necessary, etc. I think they'd be more interested in completing the deal any way possible to collect a commission.
I guess if a business broker was borought in, that's fine, so long as other professional ere brought in as well.
But it's not my deal, so wile speculating about it is fun for me, becuase I'm always looking to acquire other agencies, taking my advice off of the internet wouldn't be very prudent.
I just went and borrowed from my bank. Essentially I pledged my stock, but it is basically a partially secured signature loan. There are financing options that lend on blue sky, in my case, property/casualty insurance commissions and consultancy fees. But they're going to lend usually a dollar for a dollar, and only as the dollar is generated throughout the year, or years.
Great, except when the going rate of the business is 5X top line. Which the above business could be. Gross revenue X 5. Where most banks won't lend to most buyers at that multiple unless one's signature is extremely strong. Or will lend one year's revenue, and other sources of financing, including some of the options above, are necessary to execute the full asking price.
So I don't think the above is an extremely complicated structure, nor do I think it is unheard of. Again, predicated on the type of business, which I have no idea what it is. But the more I read through the above, the more I suspect there is some high multiple of revenue as an asking price, and no traditional banking collateral, or not enough tangible collateral.
I suggest the guy see his attorney and tax attorney. I'm not a big fan of business brokers. I'm not sure I'd trust their insight into a $10M transaction, tax implications, recourse if necessary, etc. I think they'd be more interested in completing the deal any way possible to collect a commission.
I guess if a business broker was borought in, that's fine, so long as other professional ere brought in as well.
But it's not my deal, so wile speculating about it is fun for me, becuase I'm always looking to acquire other agencies, taking my advice off of the internet wouldn't be very prudent.
This post was edited on 2/17/16 at 11:40 pm
Posted on 2/18/16 at 9:45 am to Ronnie
The question is which of the 2 is better, not whether another option is better, so I'll answer what was asked.
It's not even close, option 1 is better. 20 years is an eternity and anything projected over that term is dreaming. The 7.5% just as soon be 30% or 0% as it's meaningless. I'd value that offer on cash plus 10% of the future payments discounted as a cash flow.
5mm in 5 years on offer 1 is also a BIG, BIG, gamble depending on the economy, competitive position of the company, abilities (and life) of buyer, and unknowns. I'd only consider something like this if seller could, at any time for just about any reason, take the company back. I'd require buyer to personally guarantee the payment along with the company.
There are, of course, so many unknowns to the deal that it's impossible to say whether either are valid or not, but of the 2, 1 is by far the better option.
As far as where to get advice in Baton Rouge, forget business brokers, anyone can call themselves a business broker with no ability or experience. Talk to a GOOD CPA and attorney. I don't have names, but it shouldn't be hard to find one for a deal like this. Fees will be very high, but well worth it.
It's not even close, option 1 is better. 20 years is an eternity and anything projected over that term is dreaming. The 7.5% just as soon be 30% or 0% as it's meaningless. I'd value that offer on cash plus 10% of the future payments discounted as a cash flow.
5mm in 5 years on offer 1 is also a BIG, BIG, gamble depending on the economy, competitive position of the company, abilities (and life) of buyer, and unknowns. I'd only consider something like this if seller could, at any time for just about any reason, take the company back. I'd require buyer to personally guarantee the payment along with the company.
There are, of course, so many unknowns to the deal that it's impossible to say whether either are valid or not, but of the 2, 1 is by far the better option.
As far as where to get advice in Baton Rouge, forget business brokers, anyone can call themselves a business broker with no ability or experience. Talk to a GOOD CPA and attorney. I don't have names, but it shouldn't be hard to find one for a deal like this. Fees will be very high, but well worth it.
Posted on 2/18/16 at 10:20 am to Ole War Skule
Boutique IB deep in M&A and specialization in the industry is optimal if he wants it done right. There are plenty of small shops who will do transactions as small as $10mm. Fees will be a decent %, though that's not the time to be a cheap bastard.
This post was edited on 2/18/16 at 10:25 am
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