My first article in this series addressed this question: When the closely-held business is a substantial marital asset, what are the three main choices for turning the Departing Spouse’s interest into cash payments? My next article focused on the first alternative, a modest down payment and a long installment note, and summarized key terms that a Departing Spouse should request (and the Remaining Spouse should anticipate).

This article moves on to discuss the second alternative for an equalizing payment on the Departing Spouse’s equity interest in the business, namely the Remaining Spouse obtaining third party financing for a cash buyout of that interest. Consider this example: The family-owned business is now valued at $20 million, and the Departing Spouse has a 50% interest in that business. The Remaining Spouse can muster $500,000 in cash and offers that as a down payment, with the remaining $9.5 million to be paid over 10 years. The Departing Spouse rejects, and is ready to force a sale of the business, calculating that now receiving $10 million in cash less transaction costs and capital gains tax is safer than spending the next decade worrying that mismanagement or market conditions may run the business into the ground.

So, the Remaining Spouse is faced with raising up to $9.5 million to avoid this premature forced sale of the business. How can that amount be borrowed from a third party lender, or raised by selling equity to a new investor?

This Part I of the discussion focuses on possible lending sources for the privately-held company, which fall under two broad classes, (a) commercial banks, which can cover a broad range from the large nationwide banks to local community banks, and (b) private lenders, which range across an even broader spectrum of funds and resources.

Commercial Banks. Banks who make sizable capital loans typically look for mature businesses or companies with substantial tangible assets. The former can mean revenues in the range of $50 million to $100 million or more, with strong profitability over a meaningful period. The latter means the bank is looking for real estate, equipment and similar assets that could be liquidated at values that mitigate the bank’s risk. Many successful privately-held businesses will not easily fit into these profiles. If a commercial bank loan is available, the common terms will include interest at the prevailing market rate (either fixed or floating), a first priority lien on the business’ assets, financial performance covenants which must be met on a quarterly basis, and restrictive covenants that limit the owner’s actions.

Alternative Lenders. Private capital lenders are commonly known as “mezzanine lenders” or “subordinated debt” lenders, meaning they step into a middle level between commercial banks and equity investors. There are a wide variety of firms in this general category, each focused on particular industries and/or companies within general size and risk parameters. These lenders have a greater tolerance for risk than commercial banks, but require a corresponding greater return commensurate with that risk. Specifically, since they are providing second priority or unsecured debt, their interest rates will be higher than commercial banks and they likely will impose various additional charges, including structuring, commitment or other fees. Their loans typically mature over five years or longer, and they may require “call protection”, meaning the company is not permitted to repay the debt early unless it pays a prepayment premium to give the lender its expected rate of return. Mezzanine lenders also may require “equity kickers” in the form of warrants or options to purchase a specified percentage of equity in the Company.

Conclusion. When the Remaining Spouse must raise enough cash to pay for all or most of the Departing Spouse’s equity interest, a lender may be a funding source. However, finding a suitable lender and terms requires substantial experience and expertise. A qualified business attorney will have both the transactional experience and a network of investment bankers and funding sources to help in this process. In my next monthly article, Part II of this discussion will examine potential equity investment sources.