How Does Structuring the Sale of a Business Benefit the Owner?

Good Morning,

As we get ready to enter the early days of Spring, here in Michigan we've already had our first 70 degree day. And from what we are seeing from an activity perspective the M&A markets should be just as hot.

We are seeing a significant pickup in incoming requests for buy-side, sell-side and financing services. The quality of the deal flow continues to improve and we are hearing the same from the acquirers with whom we regularly communicate. The 2021 and early 2022 runs on acquisition market resulted in many of the "quality deals" being acquired and 2023 was left with more challenging opportunities leading many buyers to stay on the sidelines, compounded by higher interest rates and recession concerns. 2024 appears to be the end of those sentiments as we are seeing a very hungry market.

We say it in nearly every newsletter we send out: MONEY HAS TO BE PUT TO WORK!

From what we are hearing from our friends in the lending world, pipelines are starting to look pretty robust. While rates have yet to drop, confidence in the economy remains high and it is only a matter of time until rates do drop, even though some of the data is showing otherwise. The Fed maintains that we will see rate drops in 2024. It is an election year. We still believe a rate drop will hit in Q2 and likely another in Q3 but nothing is guaranteed in this world.

In this month's newsletter, we discuss the importance of appropriate transaction structuring when selling a lower middle market business. Without an experienced transaction team assisting in structuring, the Seller or Buyer can be left with serious post-closing problems. It is a complicated process and if you've never been through it before you may have no idea where to start. The Devil is in the details and we pride ourselves in making sure our clients are working with the appropriate team members to get the exact result they are expecting.

Feel free to reach out to us at any time to talk about this article or to discuss a potential transaction. We look forward to hearing from you.

TRANSACTION STRUCTURING FOR THE SALE OF A LOWER MIDDLE MARKET BUSINESS

In a previous article we commented on the VALUE that an experienced Investment Banker or Business Broker brings to the process of selling a lower middle market business.??In the later stages of the process a deep knowledge of Transaction Structuring is perhaps the most important.

The Sellers transaction team, consisting of the Investment Banker, a business transaction Attorney with specialized knowledge of advising on and preparing all the sale related documents, and a tax advisor, preferably a CPA firm familiar with the tax aspects of selling a business, should all be integral parts of the process.?A Business Valuation expert may also be part of the Team, particularly if the Seller is a C-Corporation.

In structuring the transaction, there are important tax considerations for both the Seller and the Buyer.?First and foremost is determining just what is being sold, either corporate shares/members interests, or the Assets subject to the unfunded liabilities of the Seller.??In the lower middle market, most transactions are structured as an Asset sale.?It is usually preferable for the Buyer to acquire the Assets, leaving behind potential problems with product liability, past years’ tax audits, and litigation risk created by the prior owners, but there are always exceptions to the rule. There can be good business reasons why a share or members interest sale is preferable, and an experienced Investment Banker will know when that is the case.?A simple example is when there are customer codes that are integral to the business and are difficult to obtain.

Allocation of the purchase price to the various assets being acquired has a critical impact on the Buyer’s after-tax cash flow which is needed to service the debt used in financing the purchase. Additionally, relatively recent new accounting rules will affect the carrying value under Generally Accepted Accounting Principles (GAAP) on the Buyer’s post-closing Balance Sheet. ?If the Seller is a C-Corp, the tax rate to the shareholders can be prohibitively high and must be carefully worked through with the assistance of a Business and Asset Valuation expert.??The sale of shares in an S-Corp do not present the same problems, but there remain similar problems as an Asset sale.

If the Buyer needs financing beyond what a commercial bank, or for that matter an asset-based lender can provide, there are a number of private lenders known to experienced Investment Bankers/Business Brokers that can be approached.??The Buyer’s “Capital Stack” may include Equity, Senior debt Lenders, Subordinated debt lenders, Stretch lenders, Private lenders, and the few BIDCOs that still are lending.?Because of our years of experience in assisting companies being forced by banks to locate a new lender, Mid-States is particularly well qualified to assist in locating these specialized lenders.

If there is still a shortfall, the Buyer can request the Seller to carry back a Seller’s note or attempt to structure an “Earn Out” which allows the Seller to participate in the ongoing success of the business.??Preparation of both the Seller’s Note and the Earn Out requires the specialized knowledge of experienced transaction attorneys.?These are delicate items and can if not properly papered the Seller can be left with unanticipated post-closing problems.

The role of the Seller and its management post-closing must also be addressed as a deal point.?In most cases, a customary transition period would last for six months but sometimes the Seller prefers a clean break and sometimes the Buyer requires a longer term due to their role as a “key man”.?Regardless, the role of the seller should be considered as a structuring tool as it can also be used to enhance the Seller’s upside through additional earn-outs and target bonuses.

We cannot overstate the importance of the Seller having an experienced Transaction Team.?We are able to make introductions to competent professionals with years of experience in facilitating a successful Transaction.?If you or someone you know is considering a sale of their business in the near term or is just starting to think about retirement in the next three to five years, we encourage you to reach out today.

We welcome discussion and commentary on this or any of our Newsletter articles. If you would like to discuss our services in more detail or to discuss the content in today's newsletter, please contact us to learn more about how we can assist your company or client.?