As a business owner, you probably make periodic capital expenditures, or “CapEx”—cash spent to acquire or upgrade property and equipment—to support your operations. When you replace existing equipment, these cash outflows are categorized as “maintenance CapEx”; any investment you make to support growth is known as “growth CapEx.” Whatever the type of CapEx, proper timing of these expenditures is essential, because any CapEx you make right before you sell your business could negatively impact your net proceeds.
Most M&A deals are structured as cash-free, debt-free transactions: as the seller, you get to keep your cash after all your debts are paid off. Recent capital expenditures will reduce the business’s cash, thus reducing your net proceeds at closing. That’s why we advise sellers to avoid any unnecessary CapEx right before closing—but sometimes this isn’t feasible. For example, a letter of intent typically requires the seller to conduct operations in the ordinary and usual course of business, including making necessary capital expenditures.
Some sellers, however, manage to structure the M&A transaction to account for recent capital expenditures without suffering a loss. Here are three ways you can treat CapEx in a sale to maximize your business’s value:
1. Revise your projections and valuation accordingly (growth CapEx).
Growth capital expenditures presumably will increase the business’s future revenues or profitability. But when these investment opportunities arise near the closing, it does you no good to pay for the asset and allow the buyer to reap the benefits. If this growth investment is excluded from the initial financial projections, the valuation will not reflect the positive financial impact of the investment. The solution: Revise the financial projections to reflect the anticipated value of the investment’s impact on your company’s bottom line.
2. Add the CapEx amount to the sale price (maintenance CapEx).
If the capital expenditure is for the replacement of existing equipment, its impact is likely already baked into the initial financial projections, so revision is not an option. In this scenario, you could negotiate with the buyer to “repay” you for this expense by increasing the sale price to reflect the CapEx amount.
3. Acquire the asset personally, and lease it to the company.
Another way you could recover the value of a capital expenditure you make shortly before the deal closes is to acquire the asset personally and lease it to the company. This approach would likely decrease the company’s future profitability, which would drive down the sale price. But in exchange for the lower sale price, you would receive lease payments from the buyer for its future use of the asset. Be sure to perform a detailed analysis that allows you to compare the impact on valuation against the present value of any lease payments.
We have seen sellers successfully structure recent CapEx into a transaction, but ultimately the buyer must agree to any approach you suggest. To ensure that you agree on how potential expenditures will be treated in the sale and that everything is handled correctly at closing, your best bet is to discuss potential expenditures with the buyer when negotiating the letter of intent.
CapEx is just one factor to consider when structuring an M&A transaction. PCE has experience navigating the nuances of any M&A transaction and advising our clients on how to maximize proceeds. Contact us today for more information.
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