One of the most fundamental issues that will be laid out in the Definitive Purchase Agreement, will be articulation of pricing details. Such details will include cash versus notes or other delayed payments and, if any portion of stock is to remain in the hands of sellers, specifics regarding the basis and the status of any such stock.
Our bias is always to require a substantial majority of cash at close. In many of our transactions (in fact, over half) all payment is in cash at close. Sometimes buyers will be afraid to commit all cash. We generally would argue that if the transaction payment is not at least 80% cash at close, our seller should keep looking for another buyer.
It is common for a buyer to request a portion of the purchase price be set-aside at close, pending resolution of closing balance sheet matters that may affect pricing. For example, if pricing assumed a certain AR or inventory balance to be conveyed at closing, and such balance was relatively uncertain ahead of time, the buyer might request that some amount be set aside to be adjusted post-closing as such items are finalized, typically in the next couple of months. This is not unusual and is generally reasonable if the unknown matters are deemed to affect pricing. It is important in such circumstances to very clearly define any pricing matters that might be argued, so both parties have a clean and clear understanding of the rules of the game.
If a portion of the price is to be paid in delayed notes payable, terms of those notes are critical to seller protection. Often, banks may require subordination to them, and it is critical then to define what this does to seller rights to potential foreclosure, in the event of non-payment. We have had several cases where bank notes were senior to seller notes, but only to the extent loaned at the time of closing. Subsequent additional notes were to be of another class, and were NOT to be senior to seller notes.
Sellers need to consider potential rights and what may happen to those rights in the future, as they negotiate note terms. For example, we once sold a company which accepted a very substantial note for almost a third of their purchase price. However, our seller was only willing to accept such deferred payment if the company continued to operate “as is”, without major change. Specifically, we provided that if the company were to acquire additional add-on acquisitions, the buyer would have to repay the note in full at that time. About a year after the initial purchase, the buyer found a large and they thought wonderfully attractive add-on acquisition candidate. They asked our seller if they would waive the early payment requirement to allow the additional add-on. Our seller said no. They did not want the added risk of integration of another unit. In that instance, the buyer found that they were able to refinance the seller note plus amounts needed for the acquisition. Thus, our seller was repaid in full, at about one year after the initial sale. Our seller was happy and free, and the buyer went on to grow and prosper.
Sellers also need to be very cautious if a part of the purchase price they receive is to be stock in the new company. If so, that can work well for both parties, but it is important that the expected later exit criteria be firmly established. Often, agreements may provide that if a seller wishes to exit after some initial period of time, he may do so, at pricing based on a negotiated and pre-set multiple of then current earnings. The agreement may provide for cash payment at that time, or if the cash would likely be onerous for a single payment, it may provide for scheduled payment over a couple of years. If the seller is continuing to work, but his re-sale of stock would be triggered upon his departure, it is also important to the seller that if he is asked to leave, involuntarily, pricing for his stock repurchase is reasonably protected. Those factors are more easily worked out in advance, to come up with reasonable mechanisms for both parties.
It is also critical that sellers understand the class of ownership of such stock, and how that compares or may be subordinate to other stock held by buyers. A few years ago, we sold a company in an all cash deal, where the owner was given a one-year time period to potentially reinvest 20% of his total proceeds back in the company. He decided to take that alternative, and paid cash for his 20% ownership. However, the stock he was granted was a different class of stock than that held by the buyers. The company subsequently had trouble, and operations failed. The company ended up being liquidated, and the original buyer did well, with their Class A stock. Our seller client, however, got almost nothing for his Class B stock. It was a terrible outcome for him.
It is difficult to delineate all the unusual payment mechanisms that a buyer may think of or propose for a given transaction. However, with the fundamental proviso that sellers avoid forfeit of control until they have a clear majority of the cash in hand, the outcome will be protected.
Debbie Douglas can be contacted at 314-991-5150
