Financing for Succession and Buyouts

Presented to FVCAARobert Napoli, CPA-CA

Vice President

Overview• Characteristics of successful buyouts• Types of financing available• Case study

• Subordinate debt division of First West Credit Union (Envision Financial, Valley First)

• Trusted financial partners• $120MM capacity• Lent $50MM to 35 companies in 3

years• Focus on buyouts, acquisitions and

growth• Size: $0.5MM to $10MM, all

industries

First West Capital

Successful buyouts• Good succession plan• Strategic fit for natural, motivated

buyers• Buyer is well capitalised• Strong rapport between seller and

buyer

Buyout Process

1. Identification of the buyer Internal management team grooming External search or approach

2. Planning3. Letter of intent: valuation and terms4. Due Diligence5. Securing financing: debts and equity6. Closing

The financing landscape

Secured & proven cash flow

Demonstrates cash flow Involved capital

Retu

rn

6%

25%

15%

High

Med.

Low

Ris

kSub-debt & mezzanine

Senior debt

Equity

Senior debt finance• Lowest cost but most secured / restrictive. • Favored deals:

Strategic or management buyers that are well capitalised

Strong cash flow businesses

• LOC and or term loan facilities secured by assets

• Occasionally provide cash flow term loan• Covenants will include margining and

minimum DSCR, TNW, working capital.

Subordinate Debt finance• Provides additional leverage over senior

debt• Subordinate in priority to senior debt, but

senior in relation to shareholder loans and equity

• Structures vary: Repayment flexibility Cost in higher interest rate, add on equity

features

• Classified as equity from senior lender perspective with proper subordination and postponement agreement : Subordination, postponement and standstill

provisions

Buyer’s Equity• Skin in the game and patient capital

required by lenders • Between10% to 50% of the purchase

price: Buyer’s relative net worth Buyer’s value as the operator Buyer’s risk tolerance

• Management teams may seek private equity in larger MBO deals

• Personal guarantees

Vendor financing• Requested by buyers to smooth

transition risk• For seller: unsecured, subordinated,

low return (0-12%), no control, illiquid

• From the vendor’s perspective should be minimised

Terms

Finance source

Pricing Features

Senior debt Prime + 1.5% to 3% Senior security, amortizing, restrictive covenants

Subordinate debt

13% to 16% 2nd position security, flexible repayment, covenants

Mezzanine finance

Like sub-debt plus an equity feature 16%-22%

Same as sub-debt with more flexibility

Vendor finance 0% to 12% Deeply subordinated, postponed repayment to lenders default

Equity Dilutive, 25%+ Unsecured, ownership

Case Study: Tetrad Computer Applications Situation• Leading provider of geographic information management (GIS) software• Retiring owners in their 70s• Management team of four with 60 years collective experienceChallenges• Vendors remorse• Smaller deal• Limited resources from management teamSolution• Strong advisors to steer process• Management team were logical, motivated buyers• Senior and subordinate finance to close purchase price• Earn–out to bridge valuation gap

Sources of finance

Facilities

BMO Senior Term Term loan

First West Capital Subordinated loan

Equity 22.5%

Vendor earn out Royalty on sales>$XTerms

BMO Senior Term

DSCR>1.25, TNW>600k

First West Capital

Subordinated , Stepped covenants

Management Ltd personal guarantees

Vendor earn out

Performance based and unsecured

Robert Napoli, CPA-CA

t: 604-501-4294 |  w: www.firstwestcapital.ca| e: rnapoli@firstwestcapital.ca |Langley Office: 6470 201 Street Langley, BC V2Y 2X4Vancouver Office: #408, 688 W. Hastings Street Vancouver, BC, V6B 1P1