FINANCE: Deal Structure is Key in the Sale of a Finishing Business

We’ve seen plenty of mergers and acquisitions in the finishing business over the past few years, and many majors deal occur just in the past 12 months.

But if you are a family or privately owned finishing shop and are looking to sell the business in the future, there are a few things to keep in mind to get the biggest return on your investment,

Deal structure is often the primary consideration in the sale of a business, although tax consequences play an important role. Finishing owners who have not been previously involved in the sale or purchase of a business usually believe that the major deal structure issue is “asset” versus “stock” sale. The reason for this perception is that “asset” versus “stock” is the topic of importance in articles about the business sale process, and usually the initial issue that a business owner’s professional advisors mention. The “asset” versus “stock” deal structure question has substantial tax implications beyond the scope of this article.

Suffice it to say, the Buyers of your finishing business will most likely want to buy the assets and form their own new entity to operate the business. The Seller, on the other hand, will most likely want to sell the corporate stock. The Buyers usually do not want to buy the corporate stock of the selling business for at least two reasons:
• The potential for hidden contingent entity liabilities that may come up at a later time, and
• The ability to buy the business assets separately and assign a new, non-depreciated value to them (establish a new depreciation basis). The Buyers will then be able to begin their own depreciation schedule and realize a tax shelter benefit against their future earnings.

Although the “asset” versus “stock” deal structure is certainly an important consideration in the sale of a business, it is by far not the only consideration and in most situations is not the primary consideration. It should be: “how is the Seller going to get his money.”

Obviously this issue is nonexistent if the Buyer is paying all cash to acquire a finishing business. However, in midmarket mergers and acquisition transactions, the purchase price is not always paid in cash. There is usually some type of financing from either third parties or the Seller. When a Buyer’s funds are limited, they will want a deal structure where the Seller is financing part of the purchase price of the shop or business. The Buyer should be aware of the risks involved. However, if the Seller wants to sell the business, the Seller will probably have to consider and accept some type of owner financing.

Following is an outline of deal structure issues relating to the payment of the selling price of a business.

Third-Party Financing
Third-party financing contemplates the assets of the business being sold to be used as collateral for the third-party financing. This type of arrangement is referred to as a “leveraged buyout.” Third-Party Financing is absolutely acceptable to the Seller if the third-party financing in addition to the Buyers’ funds will allow the purchase price to be paid in full in cash. However, if there still needs to be owner-financing, the Seller should be aware that the assets the Seller is selling will have a first lien on them and the Seller’s financing will be secured by a second lien.

Seller or Owner’s Financing
Seller’s or owner’s financing comes in many shapes and sizes. It can include any or all of the following components.

1. Buyer’s Note: can be as simple as a buyer signing a promissory note agreeing to pay part of the purchase price in the future. The buyer’s note can be structured with the following characteristics.

• The Buyer’s note being secured by the assets being purchased. Although as mentioned above, the Buyer’s Note may be a second lien.
• The Buyer’s note being guaranteed by the Buyer’s principal.
• The Buyer’s note being secured by third-party assets.
• The Buyer’s note being guaranteed by a third party.

It goes without saying that the better approach, from a Seller’s standpoint, would be to have a third party (a party outside the transaction) pledging assets to secure the Buyer’s note or a third party guaranteeing the Buyer’s note in addition to the Buyer. However, this approach may not always be available.

2. Covenant Not To Compete: usually important in a transaction from a business standpoint. The Buyer does not want the Seller of a business competing with the Buyer after he has purchased the business and paid the purchase price. But covenants not to compete can be just as equally important in the financing of the purchase price. A value can be assigned to the covenant not to compete (in some cases the value can be substantial) that the parties agree is payable over a period of time.

The payment of the covenant not to compete in the future is a form of owner financing without interest.

3. Consulting Contract: In some instances the Seller will agree to be available to consult with the Buyer, and for this service the Buyer will pay the Seller a consulting fee. The consulting fee will usually be paid in installments to be received by the Seller in the future. The same as with a covenant not to compete, a consulting contract is also a form of owner financing without interest. The Buyer agrees to pay and the Seller agrees to accept payment of part of the purchase price in the future.

It is extremely important for the business owner (Seller or Buyer) to involve an attorney and C.P.A. as early in the process as possible to address all of these issues and others in the business sale process.

Richard E. Brown (rbrown@crestviewcapitalllccom, 713-977-8255) is an attorney and president of Crestview Capital, a private investment banking firm; Mark Lauber (MLauber@ParadigmLP.com, 281-558-7100) is vice president of marketing with Paradigm Partners, a niche tax consulting firm.