Family Business Debt Acquisition Structure

March 13, 2023

by a searcher from University of Virginia-Darden - Darden School of Business in Charlottesville, VA, USA

I've reached a tentative agreement to buy my family's business based on a stream of income for the current owners.

Gross revenue is about $9m with an average EBITA at about $1M.

The company is about 35 years old with every year being profitable.

Here are the terms:

1) Payment equal to the owner's current salary of $100K/year for a period of 25 years (in the form of a note not an employment agreement but if the current owner still wanted to be involved he could be in a non-controlling role)
2) Increase pegged to inflation to preserve buying power for this let's say 4% per year
Year 1: 100K
Year 2: 104K
......
Year 25: 267K
3) I would like to structure this as note with constant principle payments and increasing interest so both the owner and I can take advantage of the interest deduction
4) If the owner dies before 25 years then the balance of the principle is forgiven.

With this sort of structure the net present value works out well and does not require any upfront capital outlay.

I've looked at different ways of structuring include an ARM type note and an inflation adjusted bond. None of them seem to quite do it though.

Any suggestions would be greatly appreciated.

Reply by a professional
from Villanova University in West Chester, PA, USA

Without any other information, it's hard to say whether this would be the right structure. There's certainly a way that you could structure a loan in this way, but it would be customized and it's not anything you'd find off the shelf. You'd need a lawyer with strong experience in this area to draft it. If needed, I can help with this.

However, I'm not certain that this is the best legal structure for you. There are very different issues and expectations between employment and loans. Furthermore, what if the business would go under in X years due to that high of salaries. It seems it would be less expensive to value the business as it is now, and buy it with 100% seller's note. If it were an employment agreement, it would address issues such as non-performance, termination for cause, etc. This is especially important in a family business to define expectations at the outset, especially when there is a change in control. There are also other alternatives such as providing a profits interest in the business which would then remove the employment obligations. I would recommend having a discussion with an attorney regarding all of the facts to determine the best structure. I would be happy to discuss this further.

An accountant can share their thoughts on the financial benefit of this, perhaps ^redacted‌ .

Reply by a professional
from Seton Hall University in Morristown, NJ 07960, USA

Morning! On my initial read, I think ^redacted‌'s comments make a lot of sense. But I am seeing two alternatives, salary or note, and as Laura indicated, both have distinct differences that require attention in negotiations. I really like the idea of tying the annual payout to performance in some way (and thus having deductible expense), but I don't know the industry or what you are specifically buying. For example, if you were buying a service firm, and you were tying things to the "accounts" that you were buying, then I could structure a commission agreement on the performance of those accounts for the 25-year period you've indicated. That allows you to bring in new accounts and grow the business where you piggyback off the existing infrastructure and goodwill, but you get the profits off the growth. Not sure that makes sense in a couple hundred words, so I am happy to offer a longer conversation in order to throw out some options and explore. DM me if you would like to set something up...

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