Small Business Investment Corporation (SBIC) Transaction

1. Small Business Investment Corporation (SBIC) Transaction Group 4: Matthew Cormack, Carsten Cramer, Nicolas Keller, Hajime Matsuura, Richard Quay, Deborah Weiner, Maria Dolores Tejero, Sarah Tucker

2. I. Regulatory Background II. Transaction Overview III. Agreements

3. Allows a private equity firm which finances risky small business that are unable to obtain traditional bank financing to qualify as a Small Business Investment Company (SBIC) and receive government subsidies under the supervision of the Small Business Administration (SBA) Small Business Investment Act (1958) Small Business Investment Act (1958)

4. Small Business Concerns Small Business Concerns • Businesses which are independently owned and operated and are not dominant in their field of operation. • $0.5-$32.5 million in annual receipts • 500-1,500 employees

5. Financing Small Businesses Financing Small Businesses • Equity Capital • Long Term Loans

6. Long-Term Loans Long-Term Loans Maximum interest rates, maturities and extensions of maturity Strictly Regulated Must be reasonably secured

7. Transaction Overview

8. Acquisition Acquisition John Doe and Jane Doe want to cash out their investment in ABC, Ltd., a Texas company that produces “widgets.” ABC, LLC buys the majority of ABC, Ltd.’s assets and assumes most of its liabilities. ABC, LLC also buys John and Jane Doe’s intangible assets. ABC, Ltd is liquidated.

9. Financing Financing ABC, LLC needs funds to pay for the assets. Three SBICs provide ABC, LLC with two long-term loans. In connection with the loans, the SBICs purchase warrants for stock in ABC, LLC.

10. The Sellers The Sellers • ABC Company, Ltd., a Texas limited partnership • John Doe, CEO of ABC, Ltd and owner of Jo.Doe, LLC • Jane Doe, CEO of ABC, Ltd and owner of Ja.Doe, LLC • XYZ Investment Trust

11. The Purchaser The Purchaser • ABC, LLC, a Delaware limited liability company formed specifically for the purpose of acquiring ABC Ltd.’s assets.

12. The Lenders The Lenders • First Avenue Capital Corporation • First Avenue Capital II, LP • First Avenue Mezzanine Fund, LP

13. The Agreements

14. The Agreements Asset Purchase Agreement 1 Employment Agreement 2 First Lien Loan Agreement 3 4 Intercreditor Agreement Second Lien Loan Agreement 5 Limited Liability Company Agreement 6 Subordination and Intercreditor Agreement 7 8 Warrant to Purchase Stock

15. ASSET PURCHASE AGREEMENT Start-up operations in a new company New contracts with customers, suppliers and staff Buyer doesn’t take over risk on previous deliveries Seller is taxed on profit from the sold assets Buyer can depreciate purchase price for part of the assets STOCK PURCHASE AGREEMENT Unchanged company number Company continues as before the sale Buyer takes over all “risks” Seller’s share profit is tax-free (deferred tax) in the holding company after three years’ ownership Buyer can not depreciate purchase price for the shares

16. Buyers Prefer APAs, Sellers Prefer SPAs Buyers Prefer APAs, Sellers Prefer SPAs Asset Purchase Agreement Stock Purchase Agreement • Start-up operations in a new company • New contracts with customers, suppliers and staff • Buyer doesn’t take over risk on previous deliveries • Seller is taxed on profit from the sold assets • Buyer can depreciate purchase price for part of the assets • Unchanged company number • Company continues as before sale • Buyer takes over all risks • Sellers share profit is tax-free in the holding company after 3 year’s ownership • Buyer can’t depreciate purchase price for shares

17. Asset Purchase Agreement Asset Purchase Agreement ABC, LLC ABC, Ltd. Assets Intangible Assets John Doe Jane Doe $21 million cash $6 million ABC Note 400 Voting Units each

18. Ex-Ante Protection of the Investment Adverse Selection: Sellers know more than Purchasers about assets’ value Moral Hazard: Sellers’ incentive to take care of business diminished APA 6: Representations and Warranties APA 6.10: Sellers will preserve business

19. Ex-Post Protection of the Investment Adverse Selection: Purchaser needs business to keep running as before Moral Hazard: Sellers could behave opportunistically APA 8: John Doe will maintain ABC Ltd.’s pre-existing business relationships APA 8.6: Non-competition, non-solicitation, non-disparagement

20. Adjustment of Purchase Price and Holdback Adverse Selection: ABC, Ltd has more info- purchase price may not be accurate Moral Hazard: ABC, LLC incentive to manipulate closing balance figures Moral Hazard: Ensuring sellers comply with post-closing covenants APA 6.7: Representations and Warranties APA 4.2: Monitoring Holdback amount makes it costly for sellers to behave inappropriately

21. Employment Agreement ABC, LLC Needs John Doe’s Expertise and Relationships ABC, LLC makes John Doe CEO and furnishes him with the information he needs to perform his duties

22. Employment Agreement Terminable at will Non-Competition Safeguarding the Purchaser Non-Solicitation Non-Disclosure

23. Employment Agreement Interest Alignment Performance-Based Compensation Structure

24. Loan Agreements Lien Loan 1 $5,250,000 First Avenue Entities ABC, LLC Lien Loan 2 $16,500,000

25. Loan Agreements Information Asymmetries • Entrepreneur’s main asset may be untested • Basic competency may be unknown • Viability of idea unknown High Capital Costs for Small Firms High Capital Costs Pose Problems for Lenders • Difficult to calibrate with specific risks • May attract firms with riskier business plans, neglect firms whose risk is in their size • May encourage borrowers to engage in riskier projects with possibility of higher returns

26. Restrictive Covenants Secured against ABC, LLC’s assets Strict limits on additional debt ABC, LLC can take on Restricts sale of assets in which Lenders have interest Restricts use of loan money Minimum debt-to-earnings ratios Lenders hold warrant to purchase 50% of ABC, LLC’s diluted equity

27. Intercreditor Agreement Interest Alignment: Creditors have been granted security interest in same/overlapping assets Creditors agree in advance on how to manage their competing interests in their common borrower Second Lien creditors are put in watch-dog position to secure fair value transaction by first lien creditors. Moral Hazard: First lien creditors may not seek to maximize sale price of the collateral

28. Subordination and Intercreditor Agreement Payment of the ABC Note explicitly subordinated to the first and second lien loan debts • Incentive Problem: • Risk that John Doe could divert ABC, LLC resources to ABC Note Holders at expense of Lien Holders • Potential self-dealing by junior creditors (John and Jane Doe) who are also equity holders in ABC, LLC Mandate for double dividends

29. Ownership Structure

30. Management Structure CEO Secretary Treasurer John Doe 3 Managers First Avenue Designee John Doe First Avenue Designee First Avenue Designee 2 Non-Voting First Avenue Observers First Avenue Designee

31. First Avenue Consent Rights • Certain actions of the Board may not proceed • without the First Avenue managers’ approval: • Issuance of any equity securities • Redemption or repurchase of equity securities or voting units • Approval of any business plan or annual budget

32. Drag-Along Rights • Majority members (First Avenue) can force minority members to join in the sale of the LLC if the buyer is seeking to purchase all of the LLC’s interests • If the Board approves an acquisition transaction and First Avenue agrees, First Avenue has the right to cause all holders of units or securities to take all actions necessary to complete the transaction

33. Warrant to Purchase Stock Gives holder the right but not the obligation to buy an underlying security Issued directly by the company Can be exercised at any time before expiry

34. Warrant Terms • Warrant to Purchase • 400 Voting Units • 10 Year Term • $0.01/Unit Exercise Price ABC, LLC FACII Potentially high return for very low exercise price. Tax benefits. Warrant term tacks to holding period for stock acquisition.