Best practices for agreeing for a minority share for the seller?

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19

Reply by an investor
from University of Pennsylvania in Charlotte, NC, USA

Great discussion topic and great comments above. I think the majority here will agree the considerations are highly situation-specific. Although repeating some of the previous good comments, some key considerations are: 1) What is the seller's motivation for or interest in retaining equity? 2) What is the buyer's motivation or interest in seller retaining equity? Does buyer require seller's ongoing involvement in the business? Or is the principal objective rather to reduce capital required to close? Both? Other? 3) To what extent will seller remain involved in an operating management or executive role? It's critical to have an explicit mutual understanding, as well as aligned economic interests, on this element. 4) If seller will continue to be active in management, an employment agreement is essential. 5) If seller will not be an employee, but rather passive equity, a form of transition services agreement is likely to be highly desirable###-###-#### What is the expected capital structure at close and going forward? Buyer and seller may have different ideas about optimal or acceptable leverage. Is the debt non-recourse? If mezzanine financing (with an equity feature) is possibly involved, there are additional considerations. 7) As many have noted, a shareholder agreement tailored to the situation is a must. Foremost among the considerations in this respect is whether seller's equity is economically pari passu with buyer's equity. Consider drag-along and tag-along provisions and other terms such as a form of put/call (and funding for such) as previous comments have mentioned. 8) The tax implications of retained equity, and possible related employment agreements, need to be considered and understood by buyer and seller. 9) Is seller financing contemplated along with retained equity? If so, seller is in a position of cash flow on which he/she has a partial claim going to repayment of the note he/she holds###-###-#### What is the likelihood of post-closing indemnification claims and the provisions related to settling such claims, including a dispute resolution mechanism?

.These are only a few of the considerations and issues that frequently arise. Invest in experienced legal counsel. Obviously, a contentious relationship between buyer and seller equity owners can put the business at risk. Better to ensure a meeting of the minds, alignment of interests and well-drafted documents before closing.

Reply by a searcher
from Harvard University in Omaha, NE, USA

I'll be the contrarian, and ask why do you want to do this in the first place?
1. Just by doing this, you're adding in complexity right when you're taking over the company, and now you have to live with the seller on your cap table for potentially years to come. You are going to take that company to new heights; heights that seller couldn't achieve like you will. Therefore, what value does that seller provide you going forward? And if the seller is passive/silent and won't offer his/her opinion, etc., what value are they providing other than they saved you some cash at close? Wouldn't that equity better be kept by yourself (more debt then), or getting an investor that can provide value on the Board going forward?
2. I'd encourage to explore the psychological aspect of a small business owner selling their business. I've seen it three times, and my investors have shared similar experiences as well. There will be a huge mental shift as soon as the money hits the seller's bank account. They start thinking about that next chapter and letting go. For my sellers, by the 90-day post close mark, they had moved on with life. Available to answer a question if need be, but they moved on. Now add in an equity rollover, and they are likely still to move on (got that big bag of money) but now they get to profit off your work.

Furthermore, if you're to be the operator and if you are to get the buy-in of your employees/managers, a 100% clean break is better all around. Even knowing that the previous seller is lurking around can have an affect on your ability to do what you need to do with buy-in from employees/management.

I believe the simplest action is best for the future of your acquisition. 100% buyout. Pay the seller a consulting fee or a wage to stay on for a transition period, but then get them out.

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