Ownership transitions in closely held businesses are never easy. Ownership transitions in partnerships or professional services practices can be even harder. There are often a multitude of different players involved and developing a value in the interest being purchased can be difficult. Whether you are a single practitioner looking to bring on a partner or well established organization with multiple partners, it’s important to remember that there are a number of ways to finance an ownership transition.
Any discussion on ownership change needs to start with the organization’s outside trusted advisors, including lawyers and accountants. There can be significant tax repercussions that need to be addressed and corporate documentation reviewed and updated. Strong documentation for the transaction is also key, including a good purchase and sale agreement and partnership agreements (new or updated). Utilizing a good team of advisors will help ensure that the transaction will go smoothly and can assist in identifying potential problem areas.
As the team is being formed, beginning discussions with lenders will help lead to a timely closing. Once the major components of the transaction have been agreed to, financing options can be explored in more detail. It’s important to note that there are both internal and external ways to finance a partner’s succession or buy-in and there is no “correct” answer. Finding the best financing alternative for the ownership transition will take good communication with lenders, the buyers and sellers and external advisors.
The below are brief summaries of financing options taken from real life transactions:
- Financing provided via seller debt. This might be the easiest way to complete an ownership transition as the funds needed to become a partner are provided via a note from the sellers of the interest being purchased. Loan payments can then be made directly from the new partner’s draw or salary until the debt is paid off. The sellers may receive some liquidity at the closing table via the buyer’s down payment, but much of the sale proceeds will come over time from loan payments.
- Financing provided via a Bank loan. Bank financing can play an important part of any ownership transition. When a perspective partner is buying into a professional practice the bank could make a loan directly to the new partner or make a loan to the practice. In the first scenario a full or limited guarantee from the operating entity could be necessary to ensure loan repayment. This was utilized in a recent loan provided by Camden National Bank that helped a key practitioner buy into a growing practice. When a loan is made directly to the practice, the practice does take on the risk of the ownership change. Consideration for this structure might be made via a higher purchase price or a disproportionate amount of net cash flow going to existing owners until the loan is paid. Tax implications in determining the Borrower should be considered as interest payments on the loan would be tax deductible for the partnership.
- The Combined Approach. Using a combination of both seller and bank financing is probably the most common way to finance an ownership transaction. Risk is shared between the two sources of financing though typically the Bank loan will be larger than the seller loan. This provides some immediate liquidity to the seller(s), and can also mean a slightly higher return via interest received.
Finding the appropriate financing for an ownership transition requires good communication and a knowledgeable lender that can understand the goals of the parties involved along with the nuances of the practice. A good lender will welcome the opportunity to get involved early and will consider all options to help find the solution that works. When using one of the approaches above, the lender also must ensure that other parts of the loan structure, including loan term and amortization, are consistent with the use of funds but do not create an untenable burden on cash flow. The lender needs to be proactive and responsive, so that the buyers and sellers can continue to focus on serving their clients or patients.
If you find yourself facing an ownership transition, either on the buying or selling side, remember that the commercial lending team at Camden National has the knowledge and experience to evaluate the transaction. Our lenders are ready to find a financing solution that works for all parties.