Case Study

High Quality Steel Casting and Precision Engineered Components Distributor

Case study

Greg DeSimone, typically a sell side advisor, represented the buyer, a key executive in this transaction.   The key executive signed a 5-year employment agreement with an option to purchase the company if the owner (87-year-old) passed away during the contract or upon the 5th year anniversary of the contract.

What made the business attractive to Buyer?
  • Long-term customer and vendor relationships
  • Opportunity to own a business with no cash down upon purchase
  • Company served an industry that key executive was familiar
  • Strong cash flow after normalization for family expenses
Challenges
  • Purchase option and agreements drafted before Greg’s involvement
  • Purchased agreement drafted by a trust and estate attorney and did not include normal and customary terms and conditions present in an M&A transaction, such as representations and warranties, indemnifications, and net working capital requirements.
  • The agreed upon structure, a stock sale, had significant adverse implications for the key executive post close.
  • Confusion by professionals on the sell side in the responsibility to key executive during the employment agreement and post-close roles
  • As 5-year anniversary approached, the now 92-year owner started to have cold feet on completing the agreed upon transaction.
When did Greg first meet the owner?

Greg was introduced to the key executive through social connections. During a social interaction, Greg learned the key executive had previously signed an employment agreement with an option purchase the company.  Both key executive and his wife had strong professional resumes but had never been party to an M&A transaction and were beginning to have doubts on whether they should execute the purchase option and wanted a second opinion.

Greg offered their services to help them finalize their decision.

Why did the owners want to sell?

The owner of the company was 87 years old and was looking to create an exit plan to transfer value trapped in his business into and estate that would support his two adult children and his grandchildren.

Greg’s Role and the Process:

Greg met with the key executive to assess the situation and determined that the key executive had the skill set to manage and grow the existing business, which had gotten stale as the current owner aged.

Greg prepared a market analysis to determine if the previously agreed upon purchase price was reasonable and gave the key executive a reasonable opportunity to generate a return on investment and be successful post close.

Once it was determined the deal made sense in terms of valuation, we assessed the risk factors present based on how the deal was structured.   From there Greg worked with the key executive to assemble a team of advisors to re-negotiate the agreement were applicable and navigate the diligence process leading up the close of the transaction.

Initial discussions leading up to the purchase option trigger date were fruitless as the sell-side advisor felt strong in their position that they have a deal in place and essential responded to our client “take it or leave it.”

Upon the trigger date, we evaluated the financial history and projections and determined even a suboptimal agreement and structure in place the deal marginally made financial sense.   The key executive triggered the purchase option.

The owner suddenly had cold feet and wanted to stay on, so after a year of refusing to discuss modifications to the agreement was now open to modification.

Greg and the other professional advisors leveraged the situation to negotiate multiple changes to the existing agreement to improve the financial viability post-close.

Result

The key executive was able get multiple key modifications to the agreement in exchange for an immaterial short-term employment agreement that allowed the owner to come to the office a couple of times a week.

Key modifications included:

  • Agreement to an IRS section 333(h)(10) election allowing the stock transaction to be treated as an asset deal for tax purposes which resulting in a $1.5m goodwill asset and a $500,000 tax benefit.
  • Subordination of debt, allowing the key executive to enter into an LOC with a bank to finance working capital.
  • Offsets with the existing LOC and shareholder notes against unpaid commissions which resulting in a $300,000 reduction to the seller note.
  • A fixed lease with 3-year options for the current office and warehouse space
  • Litigation carve outs, which previously would have passed to the key executive upon closing.
Postscript

The seller’s professional teams’ refusal to modify the agreement to include net working capital requirements upon transition ultimately provided the key executive with $1m in additional working capital.   The key executive also secured a key account post close that has the potential increase annual revenue by 15%.