Structuring a Deal to Protect Yourself
If you are looking at a business and the fundamentals are solid and you want to take advantage of the opportunity but you are hesitant because you are unsure about how this business will do once current management is gone, than you want to structure the deal in a creative way.
Generally speaking, most deals should be done with 100% cash upfront.
It just makes for a very clear deal and the expectations are smoother for both parties.
One person is selling and wants out.
The other person wants to buy a business.
You want to buy the business for $XXXX usually but in many cases you want to be creative with upfront + earnout.
The gray area is generally when this there are a few factors that could tip the business towards continuing forward or slowing down.
The goal of any business acquisition is to sustain what it has been doing and enhance the operations or add more fuel to the fire to grow it.
If it is unclear how this business will do and you are hesitant, that is when you want to be pretty creative to get things done.
The earnout should not be complicated as that is where things get messy. I have seen only a few earnouts work out perfect, but the goal is that you want to structure a deal favorably that avoids any kind of issues in the long run.
Let’s say the asking price for a business is $5 million and I am unsure if their current revenue escalation will continue.
If it were me and I want to be protected, I would look at it at the frame of, this lens – What is the upfront deal required for me to get started and what incentives/earnouts and protective measures can I put forth to protect myself from the event of worse case.
However, if the business is attractive to a lot of people, you may miss out on a deal and/or piss the seller off by getting too cute.
Your goal should be to get a deal done, and if you’re just low-balling, you’re not serious about the business. I would suggest you focus on something you actually want then something you’ll half-ass once you get (even if they were to accept your low ball).
Here is how I would structure a deal.
1) Upfront payment – I would make the upfront payment size-able. Let’s face it. No one wants to sell a business with most of the money on the back-end. Even if the seller accepts a low ball deal which is unlikely for anything of value, you risk pissing the owner off, and souring the entire relationship.
2) Transition – How complex is the business? How owner reliant is it? How can the seller to stay on and be incentivized for the handoff to be smooth. I would want a 30-90 day transition period typically (unless it were a more complicated business). I would incentivize the current owner with a % of sales (if there was an increase) for x period of days after to try to make this a win-win for everyone to help grow it out of the gate.
Incentivize the seller to stay on for at least x number of days with a unilateral option for a salary perhaps if they are really good. Stay tied together to the success of the business. Obviously, any good deal for a buyer will include a transition period where the seller stays on and helps the new owner get acquainted with the business and learn the ropes a bit. You want to succeed with the assets, and they generally want the same.
Make sure the Seller delivers all the assets agreed upon.
2) Earnout – I would structure the earnout with a % of sales, and an additional bonus of a % of sales that are above baseline (i.e. – If the business did $3 million annually, if it did $3.3 million, I would give a % on the $300k increase). I would generally cap both earnouts.
If I was extra hesitant about the business and I felt the seller had few options available to sell to, I would place some metrics or milestones that make sense to cross a threshold on certain numbers.
3) Promissory Notes – I would eliminate most of the language alluding to a personal guaranty or collateral. I would lean more towards a return of the assets. Again, a great deal is clear and easy to understand between buyer and seller and avoids complexity or potential disputes.
The main thing is to buy a business that makes sense that you feel is going to grow. You want to buy it for a good price, but you want it to continue to do the numbers it was doing, do better than it did, and most importantly, last for a long time or position it for an exit.
You want to have a terrific ROI when it is all said and done. The breakeven should above average when considering other deals in the same general framework or industry.
Remember, to work with Jarbly Acquisitions to maximize your deal, assist you with negotiations, and help you secure the best terms for your sale.
We have great inventory and we also find off-listing deals, where we represent & protect the Buyer in a transaction.
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Jarbly is a leader in acquisitions with expertise in helping with listings, negotiations, LOI's, asset purchases, company purchases, and real estate purchases. JARBLY has access to high net worth individuals if you are on the sell-side and businesses that may be of interest to you if you are on the buy-side.