Most sellers are focused on the purchase price for their business, and that’s understandable. After all, it’s the bottom line of the deal, right? Actually, maybe not. There are plenty of ways to structure a deal, and I always advise owners to think about what’s most important to them as they exit the business. Because the purchase price may just be one number of many they must consider.
Here are three hypothetical offers for the same business. (I priced it at $1 million just to make the numbers easier.)
Option #1: Complete sale price at closing, but the seller stays working in the business for six months – full-time, no salary.
This is a tough one for many sellers to accept. Yes, they put $1 million in the bank (before taxes), but they’re also working full time with no compensation (for someone else who’s calling all the shots.) This may not work for an owner who’s burned out and ready to leave or has other health or family issues. They may also have been working just a few hours a week in the business, making the idea of taking on full-time General Manager responsibilities – with no compensation – a non-starter.
“I’ve been drawing down $300K a year,” they tell me. “I should be compensated $150,000 for my time.” I’ve seen sellers turn down an offer like that, only to still be in the business a year later, more burned out than ever. They could have been done with the company six months ago with a million in the bank if they’d been more open to the deal.
This structure works best when the owner is approached to sell before they’re burned out and ready to leave; they still have some “gas in the tank” to run the company before they move on, and they get their full payout guaranteed.
Option #2: 80% of the sale price at closing; the seller finances the other 20% over two years and stays in the business 3 months.
Asking the seller to hold a note is a very common way to structure the deal; it makes it easier for buyers to get financing from lenders, which makes the pool of potential buyers bigger. In this scenario, the owner is also staying on through a shorter transition period, which may lessen the stress of becoming an employee after being an owner for years.
There are two risk issues the seller must think through carefully here. The first is that the new owner may not be able to make a go of the business. As an investor, the seller will lose his money if the business fails or is sold at a loss. That’s putting $200,000 of his retirement fund at risk, making it imperative that the seller know who he’s going into business with before he signs this kind of deal.
The second issue to consider is that a seller’s note is often tied to an indemnity clause designed to protect the buyer. The 20% of the sale price is also carried against any undisclosed or unexpected expenses the new owner is hit with during the term of the note. A major equipment failure right after closing, a vendor lien, a tax liability, legal issue, loss of a major account, and many other expenses or loss of revenue may all qualify as payable from the 20% of the proceeds that was withheld.
A seller has to be comfortable that he trusts the new ownership to manage the company well and that there won’t be any significant surprise expenses coming soon after closing.
Option #3: 70% of the sale price at closing; the remaining 30% paid under the terms of an earn-out clause with performance metrics. The owner stays in the company through transition.
Finally, here’s a scenario in which the owner is required to work for the company at a fair compensation, but is only paid the entire sale price when certain performance metrics are met. But this is the structure I would advise a seller to be most wary of. First, the metrics for the earn-out payments are usually about profitability. With the seller not making ultimate decisions, it can be difficult to achieve results. He has no control over the P&L statements or how money is spent.
If the new owner is unconcerned about the seller’s payout, they could make purchases or take on debt that will make a significant impact on the bottom line. Invest in a whole new fleet of trucks, for example, or move operations to a more expensive location. The seller is risking 30% of his retirement fund on someone else’s management decisions.
On the other hand, if the new owner is serious and competent, the company may thrive under their leadership. The seller may wind up receiving as much as $1.3 million for his company after 36 months. Risk and reward are obviously related.
So I always ask a seller about their goals before they get their first offer. Is it more important to them:
- To get the proceeds from the sale in full at closing.
- To exit the business quickly.
- To maximize the value they receive for the company.
The answers to these questions help make decisions about the structure and terms of the deal easier.
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About the Author: Patrick Lange
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Patrick Lange is an experienced HVAC-specific business broker with Business Modification Group based in Madison, Florida. He has a unique background in financial planning and has even owned an HVAC business himself. This makes him well-suited to working with some of the country’s most successful HVAC business owners. He specializes in companies with 1-10 million dollars in revenue and maintains a network of buyers and sellers in the industry. He sells a record number of HVAC businesses every year.
