I feel like this is sort of a silly question as the high-level structures of deals are discussed and generally understood, but when thinking through how / where cash actually moves in a partial buyout / retained equity transaction (tactically speaking), I realized I wasn't sure. I'm pursuing a deal that would be a partial buyout under the 2023 SBA rule change, and although the exact equity and deal terms are still tbd, I think the seller will retain somewhere around 10% equity and stay on in the business (which is good in this instance).
First, in that situation, in an asset sale, does he just get paid out less the 10% equity? Or does everything pay out and then does the seller need to put equity back into the business?
Second, how does a potential seller's note or earnout tie into this? I feel good that the seller and I are aligned on the principles of the agreement and that we are both working towards common ground on how it will be structured. Since he's staying on, and since he will most likely be retaining 10% of the company, do I tie that equity to performance and earnout, or do I have a separate seller's / promissory note to ensure performance or both? I'm interested to hear how others have structured this.
Last, and perhaps most tactically speaking, how does working capital factor in, particularly when the seller is retaining equity? I assume in a typical 100% asset sale, the seller takes all the money in the bank accounts and the AR, and the desired working capital PEG is deposited into the bank account by the lender and captured in the total SBA loan. If the seller is retaining equity, should they be funding the same percentage into the bank account?
In this particular instance, the seller mentioned he didn't think it made sense to take the money out of the account and then have me/him put it back in and/or for him to get paid and then have to take some of that payment and put it into the account. I'm assuming some degree of account transfer will need to take place regardless as the new account will need to be under my name/entity, but tactically speaking, how is this best approached without overcomplicating things?
Thanks in advance for the more tactical level understanding of how these partial buyouts are structured and how the money actually flows.
Partial Buyouts / Retained Equity - how/where does cash move?
by a searcher from Arizona State University
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1) Originally under the SBA rule change in 2023 you could only do a partial business acquisition with a stock purchase. However, that changed with a recent notice about three weeks ago, and you can now do a partial business acquisition via an asset purchase. The way it works in a stock purchase is you are purchasing 90% of the business and your required equity down would be based on 90%. The seller then retains the other 10% stock. In an asset purchase, you and the seller both own the new entity. The lender is just funding the 90% cost for you to acquire the business in the new entity. The seller is in essence transferring their 10% ownership to the new entity.
2) You cannot do an earn-out with an SBA 7A loan. This is specifically restricted. However, you can do a seller note with forgiveness in it. Under that scenario you would not be required to make payments on the seller note if certain metrics are not hit. You can also use multiple seller notes, those with forgiveness and those without it. It is all about what you can negotiate with the seller and what will still work with the cash flow available to service debt.
3) As for working capital, I would recommend looking at it like any transaction and expect normalized working capital to stay in the business post-closing. That working capital can be in the form of cash, A/R, inventory, etc. But you should have sufficient capital to operate at closing. The amount of required working capital will not change whether you are buying 50% of 100% of the business. The number is what it is.
I hope this helps. Again, I am more than happy to jump on a call to discuss in more detail and answer additional questions. Good luck!
1) In my 35 years as M&A broker, WC is included in price 100% of the time. Seller never ever keeps that in Asset or Stock. As a buyer YOU DO NOT want seller to call your customers after the sale unless you need to. It is unfortunate either the broker community or the ETA professors have misled the Searchers on this issue. So, for my comment below, WC is included in price.
2) Seller rolls over 10% is not the same as seller retains 10%. This is another big misunderstanding by the searcher class.
3) Assume P = 1,000,000. Equity is 100,000. Debt =750,000, Seller Note = 150,000. Seller company is XYZ.
a) 100% Asset sale: Buyer gets DFCF balance sheet which includes WC. XYZ gets 850,000 cash at closing and a 150,000 Seller Note.
b) 100% Stock sale: This is complicated, and I have heard many variations. First, assume XYZ actual balance sheet is the same as DFCF balance sheet. On the surface, 850,000 is paid to the owner of XYZ who owns the shares and 150,000 is owed to the owner of XYZ. The problem with this is that the 750,000 is not on XYZ balance sheet and XYZ cannot make debt payment. There are few ways to address this. I do not know all and can't go into that here.
4) Seller rollover 10%
a) Does this mean seller gets 900,###-###-#### ,000 cash, a Seller Note of 150,000) and retains 10%? If so, 750,000 will consists of 100,000 equity and 650,000 Debt. In this situation. buyer owns 90% for 100,000 equity infusion and seller retains 10% for leaving 100,000 on the table. This will not work. I have seen many deals fall apart when seller discovers this. I have also heard of deals closing and then sometime later seller discovering this resulting in chaos.
b) SBA 2023 allowed seller to retain equity. For this the transaction had to be a stock purchase of XYZ. That created the above problem in 4(a). Asset transaction was not allowed per 2023.
c) However, as of###-###-#### , SBA is now allowing retained equity with Asset sale. Ned more confirmation of this. But here is how that would work.
As before in the Asset purchase, Buyer would pay XYZ, 850,000 cash plus Seller Note of 150,000. Then the owner of XYZ, using some portion of the 850,000, will buy equity into buyer's NewCo which has equity capital of 100,000. How much would the XYZ owner have to pay to buy 10% of NewCo? It will be similar to what other non=PG investors on the buyer-side are paying. May be slightly more than 10,000
Most Searchers think that 10% seller rollover means seller is getting 90% of the purchase price (n the form of cash + Note + Earnout) and getting 10% equity going forward is not true because going forward the business will have debt on the books.
Also, banks do not write checks to individuals. This may require funds going into XYZ and the seller doing redemption. This might cause the XYZ balance sheet to have negative book value for a long period under buyer's ownership. Many banks are not allowed to lend to a business with negative book value. But, I guess, SBA lenders are ok with negative boo value b/c SBA leaves that up to the lender. The way to get around this to have two entities who are cross-borrowers or have 338(h)(10) election in a stock purchase.
I don't think I have covered everything, let alone accurately. I am just sharing what I have learned from lenders, CPAs, attorneys and directly from the SBA.