acquisition to complement other companies in the firm’s portfolio? What is the plan to exit the investment? How long do they plan to hold the investment? You may want to match the term of the credit facility to their planned holding period. Another common buyer is someone already working with the company. The current owner may be ready to retire and one or more of the management team is ready to move into an ownership role. In these situations, dig in to see how active the retiring owner is in the business. Is the remaining management team ready to take on the roles that the retiring owner was still serving? In other words, are you comfortable the new owners can successfully run the business without the retiring owner’s presence? Similar to a management buyout is creating an employee stock ownership plan (ESOP). An ESOP transaction is essentially a sale of the company’s stock to a trust for the benefit of the employees, which enables the owner to sell without finding a third-party buyer. There can be tax advantages as well with an ESOP. Properly establishing an ESOP requires compliance with numerous complicated laws. Working with advisors and counsel experienced with ESOP transactions is critical. Dive into the Details During the transaction, you, as the lender, are looking over the buyer’s shoulder as they conduct due diligence and negotiate with the seller. The buyer’s legal team will share drafts of the purchase agreement with you and your counsel. The goal is to learn as much as possible about the business being acquired, aka your new borrower. Remember, the seller is more familiar with the business. The seller knows what skeletons are in the closet. Watching how the seller negotiates the representations and warranties in the purchase agreement can give you clues as to where to dig deeper to ensure those skeletons don’t cause any problems. Similarly, review the seller’s disclosure schedules to the purchase agreement and ask questions about anything that looks unusual or potentially problematic. Despite thorough due diligence and solid representations and warranties in the purchase agreement, buyers (and their lenders) are still fearful the seller knows something negative about the business or its prospects that hasn’t been disclosed. To help allay this fear, deals are often structured so that a portion of the purchase price is held back and only paid out if no breaches of the representations and warranties arise after closing. Doing so motivates the seller to be as transparent as possible before the closing. One way to handle the holdback is to deposit part of the purchase price in an escrow account. If no claims are made by the buyer within a specified timeframe, usually six to 18 months, then the escrowed money is released to the seller. Another way to hold back part of the purchase price is through a seller carry-back note. The buyer signs a promissory note payable to the seller. As long as the business keeps performing, the seller receives payments on the note and eventually receives the full consideration for the sale. Seller carry-back financing keeps the seller invested in the business. Seller notes are typically unsecured and should be subordinated to the lender financing the acquisition. The purchase agreement may contain a mechanism for post-closing adjustments to the purchase price. A common adjustment is to account for any difference between the company’s actual working capital at closing and the working capital expected by the purchase agreement. A working capital adjustment discourages the seller from manipulating the company’s cash by accelerating the collection of receivables and delaying payments to vendors. For the seller’s benefit, the adjustment prevents the buyer from receiving a windfall if there is an unexpected increase in working capital prior to closing. 12 | The Show-Me Banker Magazine
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