Ways to structure acquisition deals without relying too heavily on debt.
Anyone who's explored the possibility of buying a business recently knows that the tight financing environment makes it tough to put deals together. Unlike a few years ago, today most lenders aren't willing to do highly leveraged transactions. Yet company sellers aren't exactly racing to slash their prices. For would-be buyers, says Bob Jones, president of Aimfair, an Alameda, Calif., firm that advises buyers and sellers, "bridging the gap between buyers and sellers presents real challenges." Fortunately, Jones notes, there are good ways to structure purchases without relying too heavily on debt. (One of them -- the "covenant not to compete" -- was discussed in "Striking a Better Deal" in this column in September 1991, [Article link].) Below are three more techniques Jones and his colleagues have recently used.
* Employment contracts. These are particularly effective, says Jones, if you're buying a service business (say, an ad agency or a graphics studio), for which much of the value is tied to what the owners and managers know and to their personal contacts. As the buyer, you probably don't want that value to vanish. "So it's to your advantage," he explains, "to pay the owner and perhaps other key people to stay around for a year or two." Typically, notes Jones, sellers want a premium over book value (total assets minus liabilities). But Jones suggests countering with less -- and using management contracts both to sweeten the offer and to spread out payments.
* Performance payments. In Jones's experience, this technique can work well in deals involving various types of manufacturers and contractors. The sellers might argue they should be rewarded for contracts that are still in the works. Buyers in turn may be reluctant to reward sellers until the work in question is satisfactorily completed (which may be months or years away). In the recent purchase of a general-contracting business, for example, Jones says the buyer agreed to pay the seller around $10 million; also, the seller got a fixed sum for each completed contract. "It's a good way to give the seller credit for business he hasn't yet completed," offers Jones.
* Contingency payments. In cases in which buyers and sellers have major differences about how they expect a business to perform, contingency payments can be extremely useful, Jones says. "If the buyer has doubts that the growth will continue, contingency payments give the seller an added incentive to make the transfer of ownership as smooth as possible." In the recent sale of a $5-million furniture manufacturer, for instance, Jones says part of the price was tied to the company's future net profits' surpassing an agreed-upon level. Depending on the circumstances, he says, "there are any number of benchmarks related to sales or profits that might be appropriate." -- Bruce G. Posner