Structuring deal and initiating LOI

November 01, 2020

by a searcher from Columbia University - Columbia Business School in Princeton, NJ, USA

Hi all, I have a target doing with PnL of $4M rev and $450K SDE in 2019, BS has ~$400K book value. However, in YTD 2020, sales are down 22% due to covid. The good news is variable operating expense reduction far outpaced the sales decline, generating higher cash flow. Current Book value is approx. $800K. Few questions:

1. How would an SBA lender look at this business from a lending perspective, and will they consider the cash/equity this business has on the books, even thought it's been impacted by covid?

2. How should I structure the deal? Seller is willing to stay on for 12 months transition.

3. Are there contacts that will help with LOI?

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Reply by an intermediary
from Indiana University at Bloomington in Carmel, IN, USA

Mike above has some good questions for clarification. Sales down for Covid is a pretty typical situation, For a SBA banker to be interested, sales have to be getting back to normal (or at least trending back) in the last few months. Using an Erosion Clause, structured correctly, off of the 2019 numbers is also pretty typical. Cutting variable expenses, while good short term to raise profitability, can be negative for a buyer as it was probably people that were let go and with unemployment rates dropping it is starting to be hard to replace people, so might be hard to staff back up.

The cash/equity on these size transactions are usually not a factor in the valuation, multiples are usually on a no cash/no debt basis, adding back some working capital that is added on top.

Having the owner stay for 12 months is OK (as far as the SBA, that is the maximum limit), but my philosophy is: You never want to buy a business where the owner doesn't want to stay 6 months, You never want to buy a business where the owner wants to stay longer than 6 months.

I have often been brought in by banks where an individual has found a business, but needs help in getting it to the deal table safely and efficiently. I am a firm believer that this should never be done without an advisor, similar to if you got arrested for a felony, you can represent yourself in court, but you would only have a fool for a client. I have been working on the buyside helping individuals for 15 years, so let me know if I can help you.

Reply by a searcher
from Harvard University in Minneapolis, MN, USA

I'd recommend trying to determine a peg between the enterprise value in your offer and the company revenue. To give the business time to recover from COVID, you can then adjust the value of the seller's note or an escrow account depending on whether the company hits the desired Revenue level within a given time frame. I recommend using revenue as the basis for the peg as the seller will find it more objective.

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