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The Buy-Sell Priced the Shares. It Did Not Fund Them.

Financing StrategyBorrower Advisory

Owners negotiate a buy-sell agreement as though the hard part is the price. The hard part is the cash, and the document rarely says where it comes from.

Take an illustrative case. Three partners own equal thirds of a precision manufacturer doing $3.6 million of EBITDA. Their shareholder agreement is thorough. It lists the events that trigger a buyout, fixes the value at five times trailing EBITDA, names who appoints the appraiser if the formula is disputed, and sets the terms: the company buys the departing owner’s stake, a quarter at closing within 180 days, the balance over four years with interest.

Ten years after signing, one partner decides to retire. The formula says the business is worth $18 million, so the stake is $6 million. Nobody disputes it.

Then the company has to pay it.

Which buy-sell triggers produce automatic funding A grid of five buy-sell triggers against two insurance funding sources. Life insurance funds a buyout on death, shown in the darkest navy. Disability buyout cover funds a buyout on disability only if the policy was bought. Retirement, voluntary exit and divorce produce no automatic funding from either source. One trigger in five produces cash without further arrangement. SPECIAL SITUATIONS The Buy-Sell Priced the Shares. It Did Not Fund Them. What a typical buy-sell funding clause actually pays out, by trigger. Life insurance is usually the only funding the agreement names. Life insurance Disability buyout cover Death Funds it No Disability No Only if bought Retirement No No Voluntary exit No No Divorce No No One trigger in five produces cash automatically. The clause names that one. Source: Illustrative construction on standard buy-sell provisions | Thalos Capital Research Thalos Capital ©

Three parts, and only one produces cash

A buy-sell provision has three parts. The triggering events: death, disability, retirement, voluntary exit, divorce. The valuation mechanism. And the funding.

The first two get negotiated line by line, because that is where the owners’ interests conflict. The third usually gets a sentence, most often naming life insurance on each owner, and it is the only one of the three that has to turn into money on a date the document has already fixed.

The difficulty is visible in the list of triggers. Life insurance pays on death. A separate disability buyout policy pays on disability, if one was ever bought. Retirement, a voluntary exit and a divorce produce no insurance proceeds at all. The funding sentence covers the trigger working owners are least likely to reach first, and says nothing about the ones they usually do.

What the schedule asks of the business

For the retiring partner, the agreement requires $1.5 million at closing, then $1.125 million of principal a year for four years, with interest at 7 percent on the declining balance.

The company generates roughly $1.65 million of free cash flow after taxes, capital spending and its existing obligations. In year one the agreement asks for the $1.5 million closing payment plus $1.44 million of principal and interest. That is $2.94 million against $1.65 million, a shortfall of $1.29 million, or 178 percent of what the business produces.

The four-year note on its own is serviceable, at $1.44 million falling to about $1.2 million. It is the closing payment stacked on top that breaks the first year, and the only place $1.5 million can come from on six months’ notice is the balance sheet the business runs on.

A $6.0M stake, two ways to pay for it
The agreement's first year against a facility's every year
Annual cash the company must find, against the $1.65M of free cash flow it generates. The dashed line is what the business can actually pay.
Buyout cash required per year under the agreement and under a term facility Two panels on a common scale to three million dollars, against free cash flow of $1.65 million shown as a dashed line. Under the agreement, year one requires $2.94 million including the $1.5 million closing payment, far above free cash flow, then $1.36 million, $1.28 million and $1.20 million. Under a seven-year term facility for the full $6 million at 9 percent, every year requires about $1.19 million, below free cash flow throughout. The agreement's schedule 25% at close, note over four years at 7% Seven-year term facility full $6.0M at close, 9% $2.94M in year 1 $1.29M above cash flow $1.19M every year $1.65M free cash flow year 1 year 4 year 1 year 7 178% of free cash flow in year one 72% of free cash flow, $458,000 of headroom
The note alone is serviceable. It is the closing payment stacked on the first year's note payment that breaks the business, and on six months' notice the only place $1.5 million can come from is the operating account. A facility also pays the departing partner in full at closing, which tends to make that conversation easier rather than harder.
Source: Illustrative construction, arithmetic shown in the article | Thalos Capital Research Thalos Capital ©

The schedule was never tested against the cash flow

Nobody chose a structure the business could not carry. The payment terms were chosen for fairness between the partners, the departing one wanting cash reasonably soon, the remaining ones wanting time. That is a reasonable negotiation. It simply took place without anyone modelling it against the company’s free cash flow, often a decade before the trigger, in a business that may look nothing like it does now.

The consequence arrives all at once. The remaining owners drain working capital to make the closing payment, or ask the departing partner to reopen a document everyone signed in good faith, or go looking for financing with a deadline already running.

What a facility changes

Replace the note with a term facility for the full $6 million over seven years at an illustrative 9 percent. The annual payment is about $1.19 million, roughly 72 percent of free cash flow, leaving around $458,000 of headroom where the agreement’s first year left a $1.29 million hole.

The departing partner is paid in full at closing rather than over four years, which usually makes that conversation easier, not harder. The company keeps its reserves. And the obligation becomes a single amortizing loan sized to cash flow, instead of a schedule written for a different purpose.

None of this requires touching the valuation. It requires the funding leg to be designed with the same care as the price.

How Thalos Capital Approaches This

Thalos Capital works borrower-side on Special Situations from $5 million to $100 million and above, across the United States. A buy-sell trigger is that profile exactly: a date nobody chose, an amount the document has already fixed, and a need that does not fit a standard credit application.

The useful work happens in two places. Before any trigger, modelling each event in the agreement against the company’s cash flow, so the owners know which ones the business can fund and which it cannot, and can put capacity in place accordingly. After a trigger fires, sizing and placing a facility against the business and its collateral fast enough to meet the closing date without draining the operating account.

The partners in the example agreed a fair price for a stake in a good business. What they did not agree, because nobody asked, was how a company generating $1.65 million a year would pay $2.94 million in one of them.

Most financing situations have more options than the borrower initially sees. A conversation is enough to map them. Submit your financing request at https://thaloscapital.com/contact.

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