Three common deal types for buying a business – Part 1
Let’s say we are buying a company valued at $3,000,000. Most buyers will want to use a combination of cash and debt to finance the deal. Indeed, the seller may even be asked to provide some of the debt, i.e. vendor debt. And as the buyer wanting to mitigate the risk of over-paying we can request that part of the purchase price will be conditional on the future performance of the company.
There are three deal scenarios that I’d like to cover with you in the next few blog posts. This first article covers the scenario where you could be the only buyer for a particular business and that business is easy to value.
Scenario 1: Non-bankable, limited buyer deal
There are several instances where a traditional bank will not be prepared to lend you money to acquire a business. Typically, this is because the future cash-flows of the business do not have much tolerance to changing conditions, e.g. the business could be heavily reliant on a single customer. Banks don’t take risk positions and seek adequate security to compensate their risk. If the business does have ‘customer-concentration’ and there are no tangible assets in the business or the buyers don’t want to put their houses in for securitisation, then most traditional banks will say ‘no’.
Let’s say that the business we want to buy has an EBIT of $750,000 and we are prepared to pay 4X EBIT, then the Business Asset Value is $3,000,000. (Note: If you are buying the shares in the company, you will need to adjust the purchase price to add/subtract net operating debt and net working capital).
If the buyer has only got $1,000,000 in equity and the bank wont lend any money into the deal, then the seller of the business has three choices:
- Provide vendor finance to the buyer; or
- Find another buyer who is prepared to value the company at 4X, rather than, say, 2.0X – 2.5X; or
- Not sell the business and:
- Potentially, be better off from years of on-going profits; or
- Potentially, risk losing customers, revenues, profits and staff.
This is a very common scenario. What is very important is for both parties to realise that they have choices that exist within ‘The System of the Deal’.
If you take the time to establish the framework in which a potential deal can occur then vendor finance can be a highly attractive option for both the buyer and the seller.
For more information on structuring the vendor finance terms that suit your business or next acquisition, please contact us.