Dissecting Purchase Price

When a Seller and Buyer enter into a transaction for the sale of a pest control business, the deal terms are eventually set forth in a contract which is either an Asset Purchase Agreement (a/k/a “APA”) or a Stock Purchase Agreement (a/k/a “SPA”). An APA is more common than a SPA because of a Buyer’s desire to write off the purchase price and minimize any chance of Seller liabilities being assumed. Conversely, a Seller’s owners may prefer a stock deal because of the ability to achieve lower long term capital gain taxes if the business is being operated in a C-Corporation and not in an LLC or S-Corporation. So, the type of deal structure and price for the deal will be an initial negotiation point between the parties.

However, regardless of whether the final contract ends up being an APA or SPA, there are some common elements for both types of transactions as set forth in the Letter of Intent (“LOI”). An LOI might say that Buyer is offering Seller $8.0 million for its business. However, does the definition of business include all assets or just certain assets? The LOI will specify what assets are included in the offer price (the “Purchased Assets”) and those assets that are being excluded and retained by the Seller (the “Excluded Assets”). What about Seller liabilities? Similarly, the LOI will define what liabilities are being assumed (the “Assumed Liabilities”) and those liabilities that are not being assumed (the “Excluded Liabilities”).

In the end, the offer price and how attractive it is needs to be evaluated in light of the basic assets included and liabilities assumed, if any. A Seller in evaluating such matters needs to understand the following items and how they are typically handled in current pest control M&A deals:

Vehicles, Trailers, Sprayers, Equipment, Inventory, Supplies, Computers, Furniture & Fixtures

Generally, when a Buyer makes an offer to a Seller, the purchase price is primarily tied to the value of the customer list and goodwill (the “Intangible Assets”). The value of the Intangible Assets needs to be separated from the value of the tangible assets to get a better sense of whether a premium is being obtained (or not) for the Intangible Assets.

In addition to the Intangible Assets, the Purchased Assets will typically include tangible assets such as vehicles, trailers, sprayers, equipment, inventory, supplies, computers, furniture and fixtures. For most pest control companies the other tangible assets (excepting vehicles and trailers) have minimal fair market value therefore getting an increase in purchase price for these assets would be unusual.

However, if a Seller has a fleet of 50 vehicles that could be worth well in excess of $500K then the $8.0 million offer including them as part of the Purchase Price should be viewed as being a net $7.5 million offer since Seller is essentially giving Buyer consideration back in terms of the value of the vehicles. Conversely, if another Buyer offered the same $8.0 million but also agreed to pay for the fair market value of the vehicles then the two deals are not in fact the same at all.

Accordingly, one must be careful in their negotiations when evaluating what the true Purchase Price is that’s actually being offered by a prospective Buyer. Similarly, if the offer price includes a required minimum working capital amount (discussed below) then it’s the same concept just described above for the value of vehicles, being a reduction to the perceived Purchase Price being offered.

Minimum Working Capital Requirements

Generally, a Buyer will also expect a Seller to deliver sufficient Accounts Receivable such that when collected by Buyer, the day to day expenses for running the operations (e.g., payroll, rent, utilities, etc.) will be covered for a specified period such as 30 or 60 days. Therefore, if the monthly cost to run the business is $50,000 then a Buyer may expect the Seller to deliver Accounts Receivable of $50K-$100K to allow for such liquidity needs. This position of course means that Seller is in essence giving back a portion of the Purchase Price for the value of the working capital having to be provided.

Why is this a Seller’s responsibility to fund post-closing expenses? It’s not their responsibility by default, but it’s a point of negotiation as to who gets to keep the Accounts Receivable. Similar to the other assets, the impact of Seller giving the Buyer the Accounts Receivable means the $8.0 million offer is not in fact accurate from the Seller’s perspective. A Seller needs to be looking at the net Purchase Price actually received after taking such items into account.

Customer Prepaid Deposits

Another item that affects the net Purchase Price a Seller receives is customer prepaid deposits and whether the Buyer makes an adjustment for the post-Closing obligation to provide services to customers who prepaid the cost in advance and did so prior to Closing. Since all deals provide that cash is an Excluded Asset to be retained by Seller, does this mean that Buyer will provide the services to such customers and do so at its own cost and let Seller keep the cash collected prior to the deal Closing?

While a Seller would like to think so, this assumed liability by Buyer will result in the cash component of the Purchase Price being reduced equal to the amount of the aggregate customer prepaid amount.

For example, if the Seller’s customer prepaid deposits were $200K at the time the deal is consummated then Seller’s cash in pocket at Closing will be reduced from $8.0 million to $7.8 million.
Aside from the above downward adjustments, there are positive things a Seller can and should negotiate for that will increase the offered Purchase Price, some examples follow.

Prepaid Expenses; Security Deposits

Generally, Seller will incur certain expenses before the Closing but such expenses in fact benefit Seller for a partial period prior to Closing and also benefit Buyer for a partial period after Closing. Examples of such pro-rated expenses may be subscriptions, media/advertising contracts, dues, personal property taxes, utilities, maintenance contracts, etc. A Seller has to be cognizant of such prepaid expenses and to recognize they should be partly reimbursed by the Buyer for such items that are covered post-Closing as an addition to the Purchase Price. Another item to remember is any security deposits that may be held by third parties for the office, utilities, leased equipment, etc.

The details of the LOI will spell this out as to whether such items are Purchased Assets included as part of the Purchase Price or are additional items that Seller gets reimbursed for. A Seller needs to be mindful to think about these items to protect its interest.

In conclusion, the $8.0 million Purchase Price example above would result in a $7.25 million Purchase Price net of vehicles ($500K), AR ($50K), Customer Prepaids ($200K) but before adding in any pro-rated prepaid expenses that benefit Buyer.

What should a Seller take away from this – that Purchase Price is not as simple as one would assume it would be. With a little extra thinking in advance of a negotiation, a Seller will be better poised to improve the net proceeds going in their pocket upon the closing of a deal.

The Authors are the Managing Directors of PCO M&A and Succession Specialists, LLC. For more information about how we can provide assistance to a sell side transaction, send us an email to info@sellmypcobusiness.com or visit www.sellmypcobusiness.com