deal structuring: there are more options than you might think
You have just advised your seller to accept the presented LOI and now need a lender to finance this transaction. The only concern is the $3,400,000 dollar goodwill piece included in the $4,000,000 purchase price.
By Steve Mariani
July 11, 2019
The lender you typically use for transactions seems to be hesitating a bit on the lack of collateral included in the transaction and after reviewing the financials of the buyer they realize there is not much else to place a lien on. Today, we will talk about the many options that can be used to combat this concern and get your deal closed.
Total project cost
The first thing to determine is the TPC or Total Project Cost. To understand the project cost, we must dig into the actual needs of the operation. TPC includes all the items that will need to be considered by a buyer before, during, and after closing to ensure the business continues to operate as presented. These items begin with operating (working) capital as most people know it best. That said, did you know there are really two kinds of operating capital in our financing world? Most people do not, and we will explain the differences here. There is “permanent” working capital and “revolving” lines of credit, and each is utilized for different purposes.

The “permanent” working capital is the money required to operate the business on a daily, or monthly, basis. We calculate permanent working capital to be the money required to support the ongoing expenses required to run the operation, including rents, salaries, and general operating overhead. Once we understand the needs of the operation from an overhead perspective, we need to understand the collection process and what amount might be required to support the account receivables, if any. Calculating this amount is sometimes more or less important depending upon the business’s customer base. If the business sells to other business customers and is mostly B2B, I would expect to see some amount of receivables on the balance sheet that we will have to account for in some fashion. Depending upon the amount shown on the receivables aging report, and considering the profit margins, we can determine the correct amount of capital required to support this portion of the operation. Many times on these larger transactions, a great amount of operating capital can be required. As an example, using an average receivable amount of $1,000,000 per month for an acquisition and knowing that their collection policy allows thirty days for payment, this would equate to an operating line requirement of approximately $1,500,000 just for the financing of the receivables. Three options for this additional funding can be seller notes, additional buyer injection, or lender provided financing. We would recommend that each party share in this amount to ensure the buyers success. What I mean by this is that the seller will allow the payment of a certain amount of his receivables to be paid off over time, as opposed to being paid to the them within a few days of collection, as most purchase agreements state. Other avenues might be the buyer increases their injection and the lender can also include an operating line of credit. Typically, between these three methods, we find a solution to this receivables concern and move this deal forward, and an SBA express line of credit might be the answer.

SBA Express lines now have a much longer interest-only period and are worth mentioning here. Prior to 2018, all SBA Express lines had a mandatory term out after the initial interest only period of two years. Since then, the rules have changed and now allow a lender to allow interest-only payments for up to five years, and then it terms out for an additional five years. A much better option for the above scenarios. Other structuring considerations on these transactions might include a seller consulting agreement. The SBA allows the buyer to hire the seller as a consultant for a period not to exceed one year. If your buyer is truly in need of seller support post-closing, this could be a valuable option. Reducing the selling price and offering a consultant agreement could be another great option. One more option, that I hesitate to bring to any brokers attention, is seller financing. Our firm advises against it for many reasons, but we do consider these at specific times and for specific reasons. To bridge a gap between our maximum loan amount of $5,000,000 and the purchase price, or maybe to combat a customer concentration concern, as an example, might be times we suggest seller financing.

The bottom line in all large goodwill transactions is the willingness of all parties to make the deal happen. Once we understand the motivation of each side, we can then best strike a solution that satisfies each party. Today we describe just a few of the options available for the structuring of larger loans but you should know these are just a few examples and there are many more. This is where there is no substitution for experience and lender criteria knowledge, along with SBA rule understanding. Creative structuring is only achieved through experienced, knowledgeable SBA professionals. When you really explore seller notes as a financing option, it is not typically beneficial to the transaction, and if it can be avoided, is usually in the buyer’s best interest to do so. Don’t let conservative SBA lenders convince you otherwise.
Diamond Financial Services