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Buy Out

November 22, 2009

The company’s current Chairman founded the business eighteen years ago. He has seen it grow to slightly more than twenty million dollars in gross revenues. At age 69, he currently retains 68% ownership in the company. He wants to retire and sell his interest in the business.

The company’s growth has been financed primarily with debt. Current debt consists of a $700,000 loan from the company’s major shareholder, a three million dollar loan for working capital and an additional 1.5 million dollars in long term debt. Because of the substantial debt burden, most of the company’s operating profits have been consumed with debt service and as a result there has been little growth in retained earnings.

The company’s President has been active in the industry for twenty years and has held his present position since 1975. He is currently 57 years old, owns a 23% interest in the company and has special expertise in the sales area. The Chairman’s son is the remaining member of the key management. Now 39 years old, he has worked in a variety of production jobs since the company was founded and is currently the Vice-President of Production.

This situation is one in which I was recently involved. Change the percentages or move the decimal points to the left or right and you might find a strategy that can be useful in your business. The structuring of ownership transactions can have substantial impact on value.

The company has established a reputation for its broad product line, quality and service. The company’s products are distributed nationally. The company employs over 200 people in a newly constructed facility.

The industry in which the company operates has been reasonably decentralized with a large number of small suppliers and several other medium sized firms. As a result of recent technological developments, it is apparent that there will be greater concentration in the industry with the small suppliers becoming less competitive and the most aggressive of the medium sized firms growing rapidly.

One of the other medium sizes suppliers, whose annual sales recently topped $35 million, has just completed its initial public stock offering. A growing market, an industry trend towards consolidation and favorable trends in the financial markets combined to value the stock of this company at sixteen times their per share earnings.

An investment advisor was retained by the Chairman to find a buyer for the Chairman’s stock or the entire business. A buyer was identified.

An offer to purchase the entire business had an enormous impact on the other key members of management. The assumption of substantial debt, combined with the risks associated with a change in management, minimized the per share price the buyers were willing to offer.

The impact of the sale on the management, the difficulty with financial arrangements and the resulting minimizing of shareholder value combined to cause the company to explore other alternatives.

The company’s President, already a significant stockholder, and the Chairman’s son were the likely acquires. While they may not have felt they had the financial resources, they have other strengths. They already own a quarter of the company, they can provide continuity of management and they have complementary backgrounds in sales and production.

Their weak suit is in financial expertise and financial resources. Their strong operational backgrounds coupled with the attractive multiple that the financial markets have placed on the value of the stock of a similar company in their industry, creates an excellent opportunity for outside investors to support a management bid for the company.

An outside investment group was recruited to provide the resources necessary to execute the transaction. They provided the funds that enabled the company to pay off the $700, 000 loan to the Chairman. They received in return an option to buy his interest in the company within the next two years at the current book value. They provided additional funds to retire the entire working capital loan. In return they received significant equity in the company and a note.

The company’s Chairman has agreed to place his stock in a voting trust during the option period. The voting rights will be exercised by his son, the President and a representative designated by the outsiders. Both the President and the Vice-President, along with other key management members where granted attractive stock options.

It is the company’s objective to position itself for a public stock offering within the next two years. The decreased financial leverage resulting from the debt pay down will increase earnings. Continued sales growth will place this company on a par with its competitor that recently had a successful offering. The retiring shareholder will realize an immediate repayment of his loan to the company, a reasonably priced purchase of his stock within a short time and the continuation of the firm he founded.

Because its your business, explore all the options for structuring your business transactions.

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