Deal Structures
There are many ways of structuring the transfer of business ownership in a transaction. There are a variety of unique structures that attempt to allocate risk and implement financial terms that are agreeable to both the seller and buyer. Below are a few insights on some of these and setting expectations in the process.
Define Expectations - It is well known that the majority of transactions fail purely because the seller and buyer are unable to reach a mutual agreement that meets both of their expectations. Before selling a business, it is important to define financial expectations from the potential sale of the business. Do the proceeds of the sale need to fund a retirement? Is the seller interested in staying on as a consultant full or part-time? Does the seller want or expect existing management and employees to be taken care of? Asking and answering these questions helps navigate and expedite the negotiation process. The following are a few terms that may be present in any given transaction.
Earnout - An earnout is a provision stating that the seller of the business will receive additional compensation if the business reaches certain financial goals after the acquisition. This is one form of transferring risk from the buyer back to the seller by requiring the seller to place financial faith in the future performance of the business. While placing more risk on the seller, the additional compensation can be spread out over different tax periods and can reduce the tax impact of the sale. There is often the opportunity for additional compensation if targets are exceeded as well.
Seller Note - This is a type of debt financing where the seller agrees to accept a percentage of the purchase price over time in a series of deferred payments. The inclusion of a seller note largely depends on the expected purchase price of the business and the ability of the buyer to finance the purchase price. A seller note, unlike an earnout, is not contingent on the future performance of the business. It is typically subordinated to any senior debt like bank loans or lines of credit, so this must be taken into consideration.
Financing the Acquisition - Given low interest rates and the ability to borrow money, both financial buyers and strategic buyers may be able to finance the purchase of a business. For this reason, it is helpful to understand how involved or uninvolved a seller wants to be after a transaction takes place. Strategic buyers, or companies that would realize any synergistic benefits from the merger of the company with theirs, will usually be willing to pay a higher price. Financial buyers often allow for greater involvement of the previous owner after the sale.
