As corporate acquisitions activity continues at a fast pace, more and more owners of target companies are demanding standby letters of credit from the bank that is arranging the takeover. Standby L.C.s, as they are called, legally require the bank to pay the purchase price to the acquiree if the acquiring company for some reason reneges on the deal.
Even a huge corporation with plenty of cash is capable of defaulting on a smaller company. "It doesn't matter how sound the acquiring company seems," says Gilbert W. Harrison, chief executive officer of Financo Inc., a Philadelphia-based investment firm. "When an entrepreneur sells his company, it is probably the most important financial transaction of his career. He wants some kind of guarantee that his life's work won't go down the drain."
Kay-Bee Toy & Hobby Shops Inc., a chain of retail tory stores based in Lee, Mass., obtained a standby L.C. when it was purchased for $64.2 million by a giant holding company in Harrison, N.Y. Under the terms of the letter, the holding company's bank guarantees payment of the note portion of the acquisition.
Normally, says Harrison, the buyer obtains the standby L.C. from its bank at the request of the acquiree. In return, the acquiring company pays its bank a commitment fee, usually from .5% to 1% yearly on the balance due on the purchase price.
To Howard Kaufman, CEO of Kay-Bee, the standby L.C. is akin to a security blanket. "I guess I don't trust anybody," he says. "There was a lot of money involved, and I wanted a guarantee that I would get it. The standby letter of credit gave me the security to go through with the deal."