Mergers and Acquisitions: Financing a Problem Company

Not all companies go up for sale in the rosiest of circumstances. Sometimes, Sellers need to unload debt-laden or money-losing businesses in an M&A deal. Working out financing for these so-called problem children is trickier than finding financing for healthy companies, but it’s not impossible. The following presents some problem situations and suggest ways you may be able to finance such deals.

Debt is greater than purchase price

When the external debt of a business exceeds the purchase price Buyer is willing to pay (known as being underwater), Seller is in a sticky situation. To accept the price means Seller literally has to write a check for the honor of selling his business. Short of getting Buyer to pay more (always an option worth trying!), Seller has a couple of options for selling his underwater company:

  • Ask Buyer to pay more. Seller should explain the situation to Buyer; if Buyer is hot enough for the deal, she just may be willing to pay enough to cover all the outstanding costs and debts of the business.

  • Negotiate with creditors. This situation is tricky because informing a creditor that a company is in financial trouble may cause that creditor to put place a lien on the business or force a bankruptcy on the company.

    The key is to not say the creditor will get nothing but rather that the creditor will get something. If Seller in financial straits can get major creditors to agree to accept less than the full amount owed, he may be able to extract himself from this precarious position without having to bankrupt the business.

Buyers of troubled companies shouldn’t let Sellers repay all creditors. Instead, Buyers should take complete control of the situation, ask Sellers to submit a complete list of all the business’s creditors, and directly pay all outstanding debt of the business at closing.

The business has operating losses

If a business has operating losses, Seller is wise to ask Buyer to pay for the assets of the business, which may have more value than the business. Sellers are strongly encouraged to speak with their accountants and lawyers before pursuing this course of action.

Another method of selling a business with losses is to determine the contribution, essentially revenues minus direct costs associated with those revenues (typically cost of goods sold, salespeople, marketing, and so on).

Say Seller has $30 million in revenue and $32 million in costs, resulting in $2 million in losses. Assume the direct costs associated with those revenues is $22 million. Therefore, the total nonsales and marketing administrative costs are $10 million ($32 million – $22 million).

In this example, Seller would provide $8 million in contribution ($30 million – $22 million = $8 million) to Buyer, assuming Buyer has sufficient existing administrative overhead to absorb Seller without needing Seller’s $10 million of nonsales and marketing administrative costs.

In this example, the question Seller should ask Buyer is, “What value does my company’s $30 million in revenue and $8 million in contribution have to your company?”

For the right Buyer, all or most of Seller’s $8 million in contribution would go to the bottom line. Even if Buyer figures it would need $7 million in overhead to handle Seller’s revenues, that still leaves $1 million that would fall to the bottom line. Any investment banker worth his salt should be able to make that case!

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