As 2010 draws to a close and we reflect on the economic climate, few things have really progressed from 2009 for small and medium sized businesses. Times are still tough, costs have to be minimised and maintaining or increasing profit margins still proves challenging.
This climate, coupled with the continued difficulty experienced by SME's in obtaining funding from traditional sources, means that other methods of raising funds have to be found. This has become increasingly common place in the field of mergers and acquisitions where there has been an increase in vendor finance, this is to say the vendor acting as a source of finance for the purchaser. Here at Marsden Rawsthorn we have observed this trend, particularly over the last six months, in a number of deals in which we have been involved.
One popular method of generating funds to support an acquisition is through loan notes, which are a debt instrument offered by the buyer of a Company to the Seller as part payment. Until recently the ability to use loan notes as a method of tax planning was a material attraction to the Seller. However, the way in which entrepreneurs relief operates has made loan notes less attractive as a tax planning tool to sellers, who are nevertheless under pressure to accept them, due to the credit crunch and a consequent lack of cash and other sources of funding for the buyer. Loan notes may be guaranteed, secured or insured. The tax implications of accepting payment by loan notes are complex, particularly following the changes introduced in June this year, and Sellers should approach this aspect of a transaction with care and take detailed tax advice if they are contemplating taking this step.
Another form of funding for acquisitions is deferred consideration, whereby an agreed proportion of the proceeds of sale is left outstanding on completion, to be repaid on an agreed schedule. This deferred consideration may be secured or guaranteed and may carry interest depending on the terms negotiated. For self evident reasons, some Sellers may find this form of funding unattractive, but others may be prepared to consider such an arrangement for a limited proportion of the sale consideration, particularly where the Buyer cannot raise sufficient funding to meet the price aspirations of the Seller.
A variation on the theme of deferred consideration, which is enjoying a resurgence in popularity, is the earn out. This is an arrangement whereby a business is sold and the buyer and seller agree that an agreed sum will be paid on completion, leaving a further sum payable subject to and based on the performance of the business in a predetermined time frame. This method is often used when small companies in high-growth, high-tech or service industries are sold. The buyer typically pays 70-80% of the purchase price up front with the remaining 30-20% structured as an earn out. Again this has implications for tax liabilities and again it is important to plan the taxation aspects of any such arrangement carefully in conjunction with experienced advisers.
Looking forward to 2011 there are no immediate indications of an increase in the availability of funding for merger and acquisition activity. Whilst funding generally is likely to continue to be reasonably acessible for larger organisations, the availability of funding shows few signs of permeating down to SME's. Therefore vendor finance is likely to become more commonplace. The upside of this approach for the Vendor is that is should also enable vendors with good businesses to achieve a higher price, albeit with some risk, than would otherwise been the case.
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