THE PRICE FOR A BUSINESS CAN BE MORE THAN SIMPLY HOW MUCH CASH IS PAID


What was the price for that business?

A question commonly asked................. but not always easily answered.

Consider the recent divestiture of an Omnova business to Firestone Building Products.

Both quotes in the illustration below were taken from actual publications, and both are technically correct. Yes the price paid by Firestone was $29 million, but the value of the deal was $40 million. How can this be? Because the deal did not include roughly $11 million in accounts receivable that Omnova retained and collected after the closing on top of the $29 million it got from Firestone. So Omnova will end up with $40 million at the end of the day (pre-tax).


And on the Firestone side, on top of the $29 million it would pay to Omnova, it will have a negative cash flow after closing as accounts receivable go from zero to a normal level. If $11 million is a normal level, then the total cost to Firestone will be $40 million.

This then, is an example of where price is not the same as the amount of cash paid.

In the article that follows, we will discuss some other non-cash items can be included in the concept of price.


Non-cash components of price:

  • Liabilities assumed:  If the buyer assumed liabilities of the seller, then this too needs to be included in the calculation of the price. Some of the types of liabilities that may be assumed in a deal are (i) liabilities for borrowed money or bank debt of the seller; (ii) accounts payable; (iii) accrued liabilities; and (iv) contingent liabilities such as those for environmental matters or litigation. If a buyer assumes accounts payable and accrued liabilities, such amounts may be offset against accounts receivable, inventory and prepaid expenses when determining the total price paid.

  • Stock given:  If the buyer pays for a business with its own stock, then this also would be included. If the stock is publicly traded, then valuation is a simple matter. If it is privately held or thinly traded, valuation becomes more subjective.

  • Notes given:  In some deals the buyer will give a note to the seller for a portion of the total price. Very often this is used as a means to bridge the gap between the amount of money the buyer can raise from a bank and equity sources and the total purchase price. The value of such a note will depend on its terms, interest rate, collateral, likelihood of payment, etc. and thus may be less that face value.

  • Employment contracts:  If there is a selling shareholder who is employed after the closing, an above-market employment contract is also an element that would be part of the total amount paid for the business. If the normal market salary for such a selling shareholder is say, $200,000 per year, and the deal includes an employment contract at $1 million a year for 3 years, then the seller is really getting that excess above-market as part of the deal.

  • Non-competes:  An agreement not to compete after the closing by the seller and selling shareholders (where applicable) is common in most deals. In some cases, there is a specific amount of the purchase price allocated to such an agreement and thus this amount also would be a part of the total amount paid for the business.

  • Earnouts:  Having some payments contingent on the performance of the business after the closing is also frequently an element of a deal. The uncertainty surrounding how much these payments may be may make their valuation as of the closing date difficult and subjective.

  • Assets not acquired:  The Omnova/Firestone deal where accounts receivable were excluded and collected by the seller after the closing is a good example of this situation. Other types of assets that sometimes are excluded from a deal and therefore represent additional value to the seller are real estate and plants the buyer may not want, and inventory that is off-spec.
A WORD ABOUT TAXES:  The elements of price described above are of critical importance to any seller. But what counts in the final analysis is how much cash ends up in the seller's pocket at the end of the day. And this means that taxes need to be taken into account. Structuring a deal to optimize a seller's after tax proceeds is also critically important. Should you sell assets or stock? Are you a Sub S or a C Corp.? How is the purchase price being allocated? ......all important matters that should be reviewed with a tax expert at the beginning of any process where a sale of a business is contemplated.