Structuring the Deal

Frequently, the seller of a desirable business wants to be paid 75% or more of the sale price up front.  A buyer with little cash is forced to borrow from a bank, friends, family or the seller personally, to consummate the transaction.  This kind of an arrangement usually referred to as a "leveraged buyout" where the acquirer basically anticipates that the business will generate enough cash to pay the interest and gradually pay off the loan.

Typically, these loans are required to be liquidated over 7-8 years, often as little as even 5.  The seller usually does not care about the financial arrangements the buyer makes provided he is not financing the transaction.  Lately, however, while interest rates are low, we are still in a period of credit tightening, where lenders are concerned about borrowers being over extended.  Here are some thoughts for anyone considering a leveraged buyout:

• Carefully review the interest rate demanded by the lender to assess whether the projected cash flow and earnings will be adequate to pay the interest and liquidate the debt.

• Consider giving the lender a piece of the action to lower the interest rate on the loan.  This might be accomplished by providing a warrant to purchase stock in the company at a bargain price over a specified period.

• Expect lenders to be leaning over your shoulder and placing restrictions on your compensation and on various operating expenses as long as they are at risk on the loan.

In short, while leveraged buyouts enable individuals or a firm of modest size to acquire a significant business with a relatively small cash investment, the risks are high, and you might find yourself supervised like an employee by the lender.  Therefore, we urge that these transactions be thoroughly evaluated with your CPAs (hopefully us at Abo and Company), that thorough financial projections be developed, and that you err on the side of conservatism in deciding whether to proceed with this type of transaction.