small business investment corporation (sbic) transaction
DESCRIPTION
Small Business Investment Corporation (SBIC) Transaction. Group 4: Matthew Cormack, Carsten Cramer, Nicolas Keller, Hajime Matsuura, Richard Quay, Deborah Weiner, Maria Dolores Tejero, Sarah Tucker. I. Regulatory Background II. Transaction Overview III. Agreements. - PowerPoint PPT PresentationTRANSCRIPT
Small Business Investment Corporation (SBIC)
Transaction
Group 4: Matthew Cormack, Carsten Cramer,
Nicolas Keller, Hajime Matsuura, Richard Quay,
Deborah Weiner, Maria Dolores Tejero, Sarah Tucker
I. Regulatory Background
II. Transaction Overview
III. Agreements
Small Business Investment Act (1958)
Allows a private equity firm which finances risky small business that are unable to obtain traditional bank financing to qualify as a Small Business Investment Company (SBIC) and receive government subsidies under the supervision of the Small Business Administration (SBA)
Small Business Investment Act (1958)
Small Business Concerns
Businesses which are independently owned and operated and are not dominant in their field of operation.
$0.5-$32.5 million in annual receipts
500-1,500 employees
Small Business Concerns
Financing Small Businesses
Equity Capital
Long Term Loans
Financing Small Businesses
Long-Term Loans
Strictly Regulated
Maximum interest rates, maturities and extensions
of maturity
Must be reasonably secured
Long-Term Loans
Transaction Overview
Acquisition
John Doe and Jane Doe want to cash out their investment in ABC, Ltd., a Texas company that produces “widgets.”
ABC, LLC buys the majority of ABC, Ltd.’s assets and assumes most of its liabilities.
ABC, LLC also buys John and Jane Doe’s intangible assets.
ABC, Ltd is liquidated.
Acquisition
Financing
ABC, LLC needs funds to pay for the assets.
Three SBICs provide ABC, LLC with two long-term loans.
In connection with the loans, the SBICs purchase warrants for stock in ABC, LLC.
Financing
The Sellers
ABC Company, Ltd., a Texas limited partnership
John Doe, CEO of ABC, Ltd and owner of Jo.Doe, LLC
Jane Doe, CEO of ABC, Ltd and owner of Ja.Doe, LLC
XYZ Investment Trust
The Sellers
The Purchaser
ABC, LLC, a Delaware limited liability company formed specifically for the purpose of acquiring ABC Ltd.’s assets.
The Purchaser
The Lenders
First Avenue Capital Corporation
First Avenue Capital II, LP
First Avenue Mezzanine Fund, LP
The Lenders
The Agreements
Asset Purchase Agreement1Employment Agreement
First Lien Loan Agreement
Intercreditor Agreement
Second Lien Loan Agreement
Limited Liability Company Agreement
Subordination and Intercreditor Agreement
Warrant to Purchase Stock
2
3
4
5
6
7
8
The Agreements
ASSET PURCHASE AGREEMENT
• Start-up operations in a new company
• New contracts with customers, suppliers and staff
• Buyer doesn’t take over risk on previous deliveries
• Seller is taxed on profit from the sold assets
• Buyer can depreciate purchase price for part of the assets
STOCK PURCHASE AGREEMENT
• Unchanged company number
• Company continues as before the sale
• Buyer takes over all “risks”
• Seller’s share profit is tax-free (deferred tax) in the holding company after three years’ ownership
• Buyer can not depreciate purchase price for the shares
Buyers Prefer APAs, Sellers Prefer SPAs
Start-up operations in a new company
New contracts with customers, suppliers and staff
Buyer doesn’t take over risk on previous deliveries
Seller is taxed on profit from the sold assets
Buyer can depreciate purchase price for part of the assets
Asset Purchase Agreement Unchanged company number
Company continues as before sale
Buyer takes over all risks
Sellers share profit is tax-free in the holding company after 3 year’s ownership
Buyer can’t depreciate purchase price for shares
Stock Purchase Agreement
Buyers Prefer APAs, Sellers Prefer SPAs
Asset Purchase Agreement
ABC, Ltd.Assets
John DoeJane Doe
ABC, LLC
Intangible Assets
$21 million cash$6 million ABC Note
400 Voting Units each
Asset Purchase Agreement
Ex-Ante Protection of the Investment
Adverse Selection: Sellers know more than Purchasers
about assets’ value
Moral Hazard: Sellers’ incentive to take care
of business diminished
APA 6: Representations and
Warranties
APA 6.10: Sellers will preserve
business
Ex-Post Protection of the Investment
Adverse Selection: Purchaser needs business to keep running as before
Moral Hazard: Sellers could behave
opportunistically
APA 8: John Doe will maintain ABC Ltd.’s
pre-existing business relationships
APA 8.6: Non-competition, non-
solicitation, non-disparagement
Adjustment of Purchase Price and Holdback
Adverse Selection: ABC, Ltd has more
info- purchase price may not be
accurate
APA 6.7:Representations and Warranties
Moral Hazard: ABC, LLC incentive to
manipulate closing balance figures
APA 4.2:Monitoring
Moral Hazard: Ensuring sellers
comply with post-closing covenants
Holdback amount makes it costly for sellers to behave inappropriately
ABC, LLC Needs John Doe’s Expertise and
Relationships
Employment Agreement
ABC, LLC makes John Doe CEO and furnishes
him with the information he needs to perform his duties
Safeguarding the Purchaser
Employment Agreement
Terminable at will
Non-Competition
Non-Solicitation
Non-Disclosure
Interest Alignment
Employment Agreement
Performance-Based
Compensation Structure
Loan Agreements
Lien Loan 1
$5,250,000
Lien Loan 2$16,500,00
0
First Avenue Entities
ABC, LLC
Loan Agreements
Information Asymmetries Entrepreneur’s main asset may be untested Basic competency may be unknown Viability of idea unknown
High Capital Costs for
Small Firms
High Capital Costs Pose Problems for
Lenders Difficult to calibrate with specific risks May attract firms with riskier business plans,
neglect firms whose risk is in their size May encourage borrowers to engage in
riskier projects with possibility of higher
returns
Restrictive Covenants
Secured against ABC, LLC’s assets
Strict limits on additional debt ABC, LLC can take on
Restricts sale of assets in which Lenders have interest
Restricts use of loan money
Minimum debt-to-earnings ratios
Lenders hold warrant to purchase 50% of ABC, LLC’s diluted equity
Interest Alignment:Creditors have been
granted security interest in same/overlapping
assets
Intercreditor Agreement
Creditors agree in advance on how to
manage their competing interests
in their common borrower
Moral Hazard: First lien creditors may not seek to maximize
sale price of the collateral
Second Lien creditors are put in watch-dog position to secure fair value transaction by first lien creditors.
Incentive Problem:
Risk that John Doe could divert ABC, LLC resources to ABC Note Holders at expense of Lien Holders
Potential self-dealing by junior creditors (John and Jane Doe) who are also equity holders in ABC, LLC
Subordination and Intercreditor Agreement
Payment of the ABC Note explicitly
subordinated to the first and second lien
loan debts
Mandate for double dividends
Member UnitsCapital
ContributionsPercentage
Interest
Fully Diluted Percentage
Interest
John Doe400 Voting
UnitsProperty valued at $1.2 million
50% 20%
Jane Doe400 Voting
UnitsProperty valued at $1.2 million
50% 20%
Additional Managemen
t
Up to 200 Non-Voting
Units--- --- 10%
TOTALS 1,000 Units $2.4 million 100% 50%
Warrant Holder
Units
First Avenue
Capital II, LP
20% Fully Diluted Equity Securities
50%
First Avenue Capital
Corporation
3% Fully Diluted Equity Securities
First Avenue
Mezzanine Fund
27% Fully Diluted Equity Securities
Ownership Structure
CEOSecretaryTreasurer
Management Structure
John Doe
3 ManagersFirst
Avenue Designe
e
John Doe
First Avenue Designe
e
2 Non-Voting First Avenue Observers
First Avenue Designe
e
First Avenue Designe
e
First Avenue Consent Rights
Certain actions of the Board may not proceed without the First Avenue managers’ approval:
Issuance of any equity securities
Redemption or repurchase of equity securities or voting units
Approval of any business plan or annual budget
Drag-Along Rights
Majority members (First Avenue) can force minority members to join in the sale of the LLC if the buyer is seeking to purchase all of the LLC’s interests
If the Board approves an acquisition transaction and First Avenue agrees, First Avenue has the right to cause all holders of units or securities to take all actions necessary to complete the transaction
Warrant to Purchase Stock
Gives holder the right but not the obligation to buy an underlying security
Issued directly by the company
Can be exercised at any time before expiry
Warrant Terms
Warrant to Purchase 400 Voting Units
10 Year Term
$0.01/Unit Exercise Price
FACIIABC, LLC
Potentially high return for very low exercise price.
Tax benefits.
Warrant term tacks to holding period for stock acquisition.