This is the first of a three-part series outlining the basic considerations for both business acquirers and sellers when conducting a small business transaction. This article is intended to serve as a blueprint for factors to consider prior to a transaction. Part II will focus on transaction documents, and Part III will cover post-transaction issues. If your business is looking to enter into a transaction, Stanton Law offers its services to both the buy side and the sell side of a transaction and provides the experience and resources required to foster a successful transaction.
Valuation: When looking to acquire a business, one of the first considerations is to calculate the target company’s value or understand the range of potential value. The valuation will take into account the company’s assets, earnings, industry, liabilities and debt. One common method for valuing a small business is using a multiple of SDE (seller’s discretionary earnings). SDE includes expenses – for example, income reported to IRS and non-cash expenses – as well as the business owner’s salary and benefits. This valuation is often favorable for smaller businesses, as owners typically expense personal benefits.
Capitalization Table Analysis: The cap table lists all of the company’s securities that have been issued. The cap table outlines the company’s percentages of ownership, equity dilution and the value of equity. This table may include stock issuances, sales, exercises of options, and conversions of debt to equity. The cap table is an important first step in understanding the business and a particularly useful tool in grasping the target company’s equity capitalization.
Due Diligence: There are a number of aspects of the target company that should be reviewed before completing any transaction. The evaluation will include a review of financial information such as financial statements, tax returns and any tax audit documentation. Additionally, real estate should be assessed for both value and environmental exposure. This assessment involves reviewing a list of all real property owned or leased by the target and relevant insurance policies. Any agreements and contracts entered into by the target should be reviewed as well. Another important aspect is any past and pending litigation to which the company is a party. This includes all complaints, demands and administrative proceedings (ex. OSHA investigations). Technology should also be assessed to determine potential gap areas and any IP rights the target has. Lastly, employment records, organizational charts/structure, employee handbooks and all employment policies should be reviewed.
Only after a complete review of the first three areas will an acquiring company decide to proceed.
Financing the Transaction: Once a review is complete and a purchase price has been agreed upon, there are many options for financing the transaction. The most common options include company funds, company equity and debt (e.g. leveraged buyouts, SBA loans, leveraged buyouts, loans and other third-party financing). Using company funds (100% cash) to finance the transaction is always an option, but not always the best option. Offering equity to owners of the target business can be mutually beneficial for both companies because it provides some level of continued involvement in exchange for a lower upfront cost. Leverage buyouts are also a common tool used to finance a transaction, because there is very little initial outlay, and the acquirer borrows money secured by the assets of the target. Although the relative cost of debt can reduce the overall cost of the transaction, this option should be reserved for businesses with enough cash flow to cover the debt service. Small Business Association (SBA) loans are an additional financing option that can offer a lower interest rate and longer repayment terms. Lastly, third-party financing is an increasingly popular option. Here a third party will acquire only a part of the target and will be involved in some aspects of the management of the company. Having experienced industry professionals involved in the transaction can be beneficial and can supercharge growth.
If you or someone you know is in need of assistance with a small business transaction, Stanton Law attorneys are here to help.
Stay tuned: Part II will review important considerations in the purchase documents.