Deal Structure & Getting Paid
In a majority of business sales, the seller gets a part of the sale price in forms other than cash. The times, terms and conditions of these other forms of payment, along with the upfront cash portion, all are part of what is termed the Deal Structure. Creative deal structuring is what separates novices from the more experienced business brokers. Most buyer and seller disagreements can be sorted out with the help of an appropriate deal structure that addresses the concerns of all parties involved, i.e. the buyer, the lender, and the seller. In fact, quite a few commercial lenders prefer seeing some seller skin in the game, usually in the form for delayed payments like notes, or earnouts. With that in mind, let us look at some common forms of payout and the associated pros and cons.
Cash
In my experience, most sellers like to sell for an all cash deal. This is a good structure, when you (the seller) want a clean break, and the buyer is also looking for no seller involvement post-sale. If the buyer puts down a sufficiently large down payment, most lenders will not have a problem with this.
Seller Notes
A seller note is when you (the seller) agree to loan the buyer some of the money required to buy the business. A typical deal may look like this. The buyer puts down 20%, a commercial lender puts in 70% and you agree to loan the remaining 10%. So, lets say your business sells for $1M, then in that case, you get paid $900k, and the remaining $100k is paid to you by the buyer over a period of time. There are many pros to a seller note. First of all, by reducing the buyer down payment, you are increasing the pool of potential buyers for your business. Secondly, as mentioned earlier, commercial lenders see a seller note as a vote of confidence by the seller in the business. Additionally, by spreading the payout over time, you can also spread the tax burden of the sale. Lastly, there is the interest that you get paid on the loan. The risk with seller notes is that the buyer may default on them. While that risk can be mitigated by securing the loan with equipment or assets of the company, remember that the seller note will always be subordinate to the commercial lender’s loan.
Earn-outs
Earn-outs are usually a part of the deal, when you (the seller) are expected to continue running the company for the new owner. These earn-outs are tied to revenues, profits, or other metrics like new customers etc. Buyers pay for a company based on expected future cash flows. Instead of paying up-front for these cash flows, savvy buyers hedge their bets by making some portion of the sale price contingent upon you meeting these expectations. Usually in these cases, you and buyer would have hammered out the projections prior to the deal itself, and hence you have some say in targets you are expected to achieve.
Stock
In small and mid-market sales, you (the seller) usually do not get paid a portion of the buying company’s stock unless you are expected to continue working with the buying entity. When it does happen, it is important to keep in mind the risks and rewards of getting paid with stock. Firstly, unless you are getting bought out by a large public company, the liquidity of the stock should be your biggest concern. The stock of private companies is illiquid and cannot be cashed at will. There are conditions on when and to whom stock can be sold. Additionally, valuing this stock is always a problem, since there is no market for the stock. The company may have to go through a formal valuation at the time you wish to cash this stock. Because of all these issues, it is rarely a good idea to take your entire payment in stock. On the plus side, stock gives you the biggest potential upside of all the methods of getting paid. Structured correctly, the taxes on the sale can also be deferred to the time when you sell your stock.
