We meet at the offices of Blog Topics, Inc. (BTI) to hopefully reach an agreement on a merger of Best Blogs Ever, Inc. (BBE) and BTI. Bob and Mary Pat, the owners of BTI have their attorney, Dennis, with them and their senior blog writers, Will and Catherine. BBE is represented by our President, Alice, our attorney, Carl, Mary Jo, our financial consultant and me. The general outline of the merger has been agreed upon as a swap of the common shares of BTI for an issue of preferred stock of BBE. We have also discussed the issuance of some common shares to the BTI staff in order to ensure their continuing to work for BBE after the merger.
The first order of business is to arrive at a value for BTI as a business, which translates directly into the value of the BTI shares to be swapped by Bob and Mary Pat. Following the earlier advice of our attorney, we ask them what they want for the company. Mary Pat indicates that they think BTI is worth $700,000. Since BTI had GAAP earnings of $40,000 for its last year of operations, this translates into $200 of earnings per share. Using a price/earnings ratio (P/E) of 17.5, the value of each of the 200 outstanding shares of BTI would be $3,500. With the same methodology, Mary Jo, our financial consultant, had earlier arrived at a value of $600,000 for BTI, using a P/E of 15. After more negotiations back and forth, we agree on a P/E of 16.25 for the BTI shares. Using that multiple on the earnings of $200 per share, the value of each share is $3,250 for a total of $650,000 for the 200 shares owned by Bob and Mary Pat in BTI.
Now the question is how to pay the $650,000. We had reached preliminary agreement on the idea that BBE would issue a series of preferred shares to be exchanged for the common shares. When VFI had made its $60,000 investment in BBE's newly issued cumulative, convertible preferred shares, we had established a par value of each share of $100 and issued 600 of the shares. Earlier, there had been
discussion about a par value of $500 per share, but everyone agrees that
is too low given the price of $650,000. We agree that BBE will issue preferred shares with a par value of $1,000. Because BBE has already issued one series of preferred shares, the ones owned by Bob and Mary Pat will be the second series, with a different par value and dividend rate. Their shares will be subordinate to VFI's shares. This means that VFI's shares are prior to the second series and would be paid first if we were to liquidate the company and pay out all of the share holders. VFI would be paid for its senior preferred shares first, then Bob and Mary Pat would be paid for their second series of preferred shares, and finally the owners of the common shares would receive the balance. All of these equity shares would be junior to any debt owed by the company, which always gets paid first..
The problem, from our perspective, is that any dividends paid on the new preferred shares to be issued to Bob and Mary Pat will not be tax deductible. We know how much we will be paying for BTI, $650,000, but how that amount is to be paid to Bob and Mary Pat remains open for discussion. It would be good if some of that purchase price could be deducted by BBE on its tax return. Carl, our attorney, suggests that Bob and Mary Pat might continue to work for us after the merger is completed. They want to retire and enjoy themselves, but would be willing to devote a limited amount of time to the business. They had drawn combined salaries of $60,000 in the previous year. Any salaries paid to them would be deductible. They agree to work for BBE on a part time basis as consultants to help in the transition of BTI's blogging business into ours for two years after the merger is completed. They would make themselves available on a limited basis (no more than 10 hours per week) to help us run the combined operations for this two year period. In return for this help, BBE would continue paying each of them their previous salaries of $30,000. We do not expect to need their help for the entire two years, but this is a way to convert some of the purchase price for BTI into a tax deductible $120,000 paid over that two year period. In addition, we will pay them a combined $60,000 for one more year after their consulting period is over for a covenant not to compete agreement. Under a covenant not to compete agreement, they agree to neither work with another blogging company nor start up another blogging business and, in either case, compete with BBE. The payments for the non-compete agreement will also be tax deductible. With these payments, the amount to be paid in BBE preferred shares is reduced to $470,000.
Bob and Mary Pat appear to be getting less of a purchase price for their company, but on a cash flow basis, they are getting paid some of the money sooner than if they received only preferred shares.
We will rejoin the meeting in the next blog.
Comments are always welcome.