As part of our series of articles on letters of intent (hereinafter referred to as the “Letter” or “Letters”) in commercial transactions for the sale of shares (https://endlex.ca/letter-of-intent-definition-and-purpose/), we’re going to take a closer look at negotiating the balance of the sale price at the Letter stage. This article is the first of several to be written in collaboration with Libe), a company offering consulting services in financing and the purchase and sale of businesses.
1. Balance of sale
Depending on the nature of the transaction and the negotiations between the parties, they may agree that the seller will receive a portion of the sale price at closing, and that a balance of sale (the “Balance”) will be payable according to the terms agreed upon by the parties. Over the next few articles, we’ll be taking a closer look at other notions relating to the Balance.
Firstly, the percentage of the sale price that constitutes the Balance varies according to the nature of the transaction but is usually between 10% and 25% of the sale price. In some cases, however, the Balance may exceed these percentages and even constitute the entire sale price. In such cases, the transaction is said to be fully financed by the seller.
Payment of the Balance is usually subject to terms and conditions, including a term for payment of the entire Balance, monthly, annual or quarterly payments, the applicable interest rate, if any, and other ancillary terms and conditions.
For the Seller, negotiating the payment of the Balance is an essential part of the transaction, for obvious reasons. He is selling his business without receiving the full consideration at the closing date. The payment of the Balance affects the Seller’s future pension plans, and in one way or another, part of his pension fund is affected by the buyer’s management of the business after closing, a factor which is beyond the Seller’s control. Therefore, the seller has a natural interest in negotiating a non-Balance transaction. However, various circumstances, such as the scarcity of potential buyers, or financing as discussed in the next paragraph, may make it advisable to accept a Balance.
Regardless of the circumstances, the seller must ensure that he has as many elements as possible to guarantee payment of the Balance. It is therefore advisable for the seller to negotiate, among other things, a movable hypothec on the company’s assets after the closing of the transaction, a personal and joint and several guarantee by the buyer for the repayment of the Balance, or even default clauses that allow the buyer to claim full payment of the Balance despite the deadlines initially agreed. It is also advisable to negotiate rights of supervision over the company’s financial affairs after the sale (for example, the right to review quarterly figures), in order to anticipate any situation that might affect payment of the Balance. In addition, as mentioned in our previous article (https://endlex.ca/letter-of-intent-and-financing-conditions/), it is advisable for the seller to add to the Letter that the financing conditions are also to the seller’s satisfaction as regards the buyer’s ability to pay the Balance.
The following section explains how financing a commercial transaction can affect the payment of the balance.
2. Balance and financing (in collaboration with Libe)
When transferring a business, the Balance can play a crucial role in a buyer’s bank financing for a commercial transaction. Balance is a financing tool that can positively affect bank financing, as is detailed below.
A. Reducing the initial financing requirement
When the seller accepts a Balance, the buyer does not need to finance the entire purchase price. This reduces the amount of the bank loan required to complete the initial purchase of the business. The Balance can even be considered as equity for the buyer, thus reducing the initial outlay. We will discuss the criteria for “quasi-equity” below.
B. Improved risk profile
For the bank, having part of the sale price financed by the seller can demonstrate the seller’s confidence in the company’s ability to generate sufficient future income to pay the balance. This helps to improve the buyer’s risk profile in the eyes of the bank, making the loan potentially more secure. In effect, the seller has a vested interest in the continued success of the business, since he depends on future payments to receive all his money.
The Balance also helps demonstrate the seller’s willingness to make a smooth transfer to the buyer and reinforces the buyer’s confidence in continuing to generate the necessary profits.
Note that it is generally advisable to include a transition period for the seller of at least 3-6 months in the Letter.
C. Reinforcing the buyer’s financial solidity
As the buyer reduces his down payment, this leaves more cash available for future needs, the investments required to maintain and develop the business.
A better initial cash position and reinjection capacity will always reassure the bank about the buyer’s ability to meet financial obligations and unforeseen events.
D. More favorable financing conditions
With a reduced initial financing requirement and lower perceived risk, the bank may offer more favorable loan terms, such as lower interest rates or longer repayment periods. This can make loan repayment more manageable for the buyer, increasing the chances of a successful business transfer.
E. Strengthening cash flow
Repayment of the principal balance will often be extended (i.e. deferred) by the creditor (the bank). Since the bank will sometimes provide the buyer with a repayment break on the bank loan principal within the first few months (usually 3 to 12 months) of the repayment schedule, the bank may also ask to offer similar concessions in relation to the Balance.
Extending the principal of the Balance by 3 to 5 years can sometimes be considered “Quasi-Equity” in the transaction and reduce the initial down payment.
Extensions and capital vacations thus help the company’s cash flow by reducing the total debt payment.
The Letter can also include certain ratios, such as the FCCR (Fixed Charge Coverage Ratio), which must be met to allow early repayment of the SPB.
In short, the Balance facilitates bank financing and helps make the business transfer more viable and attractive for both parties involved, as well as for the lending bank.
3. Conclusion
Negotiating the Balance is a crucial aspect for both seller and buyer, so don’t hesitate to contact us to find out more!
This article was written by Endlex in collaboration with Marc-Antoine Chaput (Financing and Business Transfer Consultant) at Libe)
The information provided in this article is for informational purposes only. It does not constitute legal or financial advice and should not be read or interpreted as legal advice. Should you require legal or financial advice in relation to the information provided in this article, please contact one of the lawyers at Endlex, or Marc-Antoine Chapout at Libe.
