Complicated sources and uses (?) - many moving parts
This is an asset purchase. The purchase price is 4.5 x EBITDA of $5mm = $22.5mm.
The Buyer is assuming $7mm of long term debt related to the assets being acquired.
The Seller is responsible for paying off the $5mm line of credit.
There is no other debt.
Transaction fees are estimated to be $1mm.
Per the terms of the transaction, the Seller is providing a 5mm seller note and has agreed to a $4mm earn out. In addition, the Seller has agreed to invest an amount of cash sufficient to purchase 20% of the NewCo equity.
Is the following Sources and Uses correct?
Sources
Long Term Debt: $7mm
Sponsor Equity: $6mm ( plug = total uses of $13mm less $7mm long term debt; of this equity, 20%, or $1.2mm, provided by Seller and $4.8mm provided by Sponsor)
Total: $13mm
Uses
Pay off / Refinance Long Term Debt: $7mm
Pay off Line of Credit: $5mm
Transaction fees: $1mm
Total: $13 million
In calculating the amount of cash the Seller receives at Closing, I come up with:
Enterprise Value of $22.5mm
Less earn out of $4mm
= closing enterprise value of $18.5mm
Less Long term debt of $7mm
= closing equity value of $11.5mm
Less pay down of line of credit of $5mm
Less cash invested for 20% equity stake of $1.2mm
= $5.3mm net cash to Seller at closing
(Seller also has a $5mm seller note and a $4mm earnout but I don't include those in net cash to Seller).
Is this accurate?
Any help would be greatly appreciated!
If I help you with this, can I get an interview at your firm? You know, since you're an MD at a PE firm and all.
we're not hiring but happy to help if i can.
That's not very complicated.
Sources: Assumed Debt: $7.0m Seller Note: $5.0m Sponsor Equity: $9.2m Seller Equity: $2.3m
Uses: Equity Purchase Price: $10.5m Payoff Existing Debt: $5.0m Assumed Debt: $7.0m Fees $1.0m
That assumes that the only debt in the business is what you've listed above.
The earnout is not a source or a use of funds. If the 4.5x Purchase Price includes a portion of the proceeds paid via an earnout (I don't know why'd you represent the purchase price like that), then you'd essentially deduct $4m from the equity purchase price and add a $4m Earnout component to each side.
Thank very much Marcus!....but I do have a few questions.
The 4.5 x purchase price ($22.5mm) does include a $4mm earnout -- meaning if it was a completely vanilla all cash deal (not as described above), the Buyer would only have to come up with $18.5mm. I don't understand your comment about how I am representing the purchase price. How would you represent it? With this understanding, should the earnout show as both a source and a use of funds?
A few other questions: Is it correct to include the seller note as a source even though it is not a closing cash item (I view it as an IOU due in 5 years)? Is my calculation of the Seller's cash proceeds at closing correct?
I greatly appreciate your thoughts. Thanks in advance.
I (personally) don't consider the earnout as a part of the purchase price for multiple purposes since its essentially a contingent payment. It doesn't actually change the math, so its really just a matter of preference.
Many of the sources and uses items are non-cash and can offset each other, so again its really just a matter of preference and how you choose to show the items on your S&U.
In my opinion, the main goal of the S&U is to demonstrate how the deal is structured, so I wouldn't necessarily collapse offsetting items. As such, I would leave the Seller Note on so that its clear that the seller is taking a note as part of the consideration. If you didn't include the seller note as a source than you would reduce the equity purchase price by the seller note amount, which wouldn't communicate (a) the actual purchase price and (b) the seller note.
Like I said before, since you're including the earn out in the purchase price, I would reduce the equity proceed amount by the earnout amount since that's not something you need to fund at closing (or possibly at all).
I also like to include the structural items even if you could effectively cancel items out from sources and uses. So, since the earnout is included in my characterization of the purchase price, would your sources and uses be:
Sources: Assumed Debt: $7.0m Seller Note: $5.0m Sponsor Equity: $6.2m (reduces by $3m) Seller Equity: $1.3m (reduces by $1m)
Uses: Equity Purchase Price: $6.5m (reduces by $4m) Payoff Existing Debt: $5.0m Assumed Debt: $7.0m Fees $1.0m
??
Also, I am very focused on getting cash to seller number right. Can you comment on that?
I agree with @Marcus_Halberstram's analysis except the $5.0mm under uses should be a seller note and not paying off the revolver, as that is the responsibility of the seller and so will not be reflected in the closing transaction balance sheet (unless I'm misunderstanding something). Might also want to label your sources/uses of seller cash for equity purchase as rollover equity instead, just to be clearer.
Sources: Assumed Debt: $7.0m Seller Note: $5.0m Rollover Equity: $2.3m Sponsor Equity: $9.2m
Uses: Assumed Debt: $7.0m Seller Note: $5.0m Rollover Equity: $2.3m Cash to Seller: $8.2m Fees: $1.0m
Strange deal
Just because the seller note and debt payoff are both $5m doesn't mean one is paying off the other, the S&U are fungible. If anything the seller note is paying the equity since it nets against each other and represents the proceeds to the seller.
$5m Revolver payoff should be a use under the assumptions OP laid out. If the business is trading on a EV basis, the EV is the same regardless of the amount of debt outstanding, its just a line swing between debt and equity.
As you've shown it... you have a use of $5m for seller note, which makes no sense. Its only a source, not a use.
You're paying X amount for the equity, Y amount of it is coming from the seller note. X and Y happen to be the same counterpart, so the net amount is X-Y.
Alright I had a different response here but I figured this would help clear things up better. Let's say you have a cash free, debt free company with a purchase price of $20mm. Let's further assume no closing costs to make this as straightforward as possible. Let's say you negotiate a $5mm seller note and pay the rest with cash. Here's how I assume the sources/uses would look based on my understanding:
Purchase Price: $20mm
Sources:
Sponsor Cash - $15mm Seller Note - $5mm
Uses:
Cash payment to seller - $15mm Seller Note - $5mm
Where am I going wrong in this? I may just be confused, I'm fairly new to the field and the Partners at my firm put it on both sides of S&U but it might just be them being lazy or something.
Seller note is a non-cash source and use. It's consideration to the Seller's even though no cash related to the note is changing hands at close.
Small correction to my earlier response -- i got the sources slightly wrong; they should be:
Sources: Assumed Debt: $7.0m Seller Note: $5.0m Sponsor Equity: $6.0m (reduces by $3.2m) Seller Equity: $1.5m (reduces by $.8m)
This maintains the 80/20 sponsor / seller equity split.
I also agree with Marcus that the seller note is a source, not a use.
I still disagree, and agree with @"Eric Stratton" but would love to hear @"Marcus_Halberstram"'s response as I definitely could be wrong and he has a lot more experience than me.
Also I don't know why one of your uses would be to pay off the revolver, when that is the seller's responsibility. I suppose I assumed the purchase price listed already took this into account, though now that I read it I don't know how I made that jump in my mind.
How much cash is the Seller getting at closing? Is it:
Enterprise value at closing: $22.5m Less earn out: $4m Less long term debt: $7m Less line of credit: $5m Less seller equity investment: $1.5 Net cash to seller at closing: $5m
This isn't correct.
The purchase price is $22.5M + $1M of fees. So we have established that the sources and uses side will both need to be $23.5M.
The equity account will be $11.5M ($23.5M total uses less $7M assumed debt and $5M seller note). You are saying the Sellers want to own 20% of NewCo so that is $2.3M ($11.5M x 20%). This means the Sponsor Equity will be $9.2M ($11.5 less $2.3).
So sources are:
Assumed Debt: $7.0 Seller Note: $5.0 Rollover Equity: $2.3 Sponsor Equity: $9.2 Total: $23.5
You are saying they have $5M of outstanding debt not being assumed so that will be paid off out of Seller's proceeds.
So the uses are: Debt Repayment: $5.0 Assumed Debt: $7.0 Seller Note: $5.0 Rollover Equity: $2.3 Cash to Sellers: $3.2 Fees and Expenses: $1.0 Total: $23.5
Think about each source and use in terms of cash vs. non-cash.
Re: revolver pay off, the enterprise value is the enterprise value, doesn't matter how much debt is outstanding, the business is worth what its worth. Paying off debt or not paying it off is just a line swing between debt to equity. So if the purchase price is $22.5m, and that's what you're paying for it, the $5m is paying off the revolver, balance $17.5m goes to seller's pocket. If you assume the seller pays it off himself, then you're still paying $22.5m, only diff is that $22.5m of that goes to seller (still same math, he nets $17.5m based on his outlay to repay revolver).
Re: seller note, as long as you deduct it out of the purchase price on the uses side, I guess it makes sense, just a bit counter intuitive (to me).
Maybe the moral of the story is there are a lot of different ways to skin this cat. The goal (IMO) should be to show in as simply as possible while communicating the key structural components of the transaction.
Recall that the purchase price of 4.5 x EBITDA includes the earnout, the assumption of the LOC by the Seller, and a Seller note as structures for the deal.
In determining the allocation of the closing enterprise value (i.e. EV not including earnout), I have the following calculation.
Closing enterprise value = $18.5m ($22.5m - earnout of $4m) Less long term debt of $7m Less line of credit of $5m = Net equity value to Seller = $6.5m (this is prior to / includes Seller equity rollover)
If this is correct, shouldn't the uses of funds be: Equity purchase price $6.5m Pay off line of credit $5m Assumed debt $7m Fees $1m Total $19.5m (= EV - earnout + fees)
Do people agree with these calculations?
Thanks.
Dude, figure it out, it's not rocket science. Its pretty intuitive if you think through it in steps.
If you are employed professionally and you're relying on WSO to get to your answer, that initial qualifier won't hold true for long.
Do you understand what an earnout is? I would start by figuring that out.
As Marcus mentioned, there are many different ways to setup the sources & uses. However, the accurate way to do it should be to follow the structure outlined in the purchase agreement. Try reviewing your APA to see if it states exactly how the cash and ownership flow in the transaction.
Also, it was mentioned before and I think it is resolved, but don't include the earnout in the funds flow.
Tangentially related: I'm not a tax expert, but I suspect there would be negative tax consequences for the seller if the stated purchase price were inflated by the earnout even if the earnout wasn't paid at closing.
If you ever see @"Marcus_Halberstram" at Texarkana tell him he's a dickhead
PE interview prep.
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