Deal Structure Brainstorm - SBA, Earnouts, Seller's Notes, etc

February 22, 2021

by a searcher from Northwestern University - Kellogg School of Management in Philadelphia, PA, USA

I am in process of buying a business that had a poor 2019 and a record###-###-#### Owner believes 2020 is sustainable, I"m concerned 2020 was simply 2019 carryover. What ideas do you have for deal structure where I can pay him for historical performance initially, then pay more in future if 2020 proves sustainable? Earnout was initial thought, but not allowable with SBA loan. Seller's note perhaps, but of course don't want to be obligated to pay if 2020 does not sustain. What other ways have you done this?

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Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

We do quite a bit of acquisition financing. I would confirm that seller notes are the best way to get around this issue. Make the seller carry as much of the upside risk as possible. Truthfully, you are likely going to run into two other issues in getting the deal approved without a large seller note. First, the business valuation the SBA requires is unlikely to come in for maximum value based on one year of history alone. Usually the valuation takes into account a couple of years. The Bank's advance cannot exceed the valuation. Secondly, lender's may struggle to get comfortable on one year of cash flow only. You are going to want the deal to cash flow or come close to cash-flowing based on the senior debt in 2019 as well as###-###-#### The cash flow is less of an issue than the valuation is if we can really explain what happened with the business and prove it will continue. The further you get into 2021 with cash flow continuing at 2020 levels on a monthly basis, the easier it becomes from both a valuation standpoint and a cash flow standpoint as both the evaluation firms and the SBA look at historical years, trailing 12 months, and interim periods and compare them. So the more periods available (trailing 12 months and interim in###-###-#### that still show support for the deal at 2020 levels, the easier it will be to get it done.

Reply by a searcher
in Tampa, FL, USA

To build on ^redacted‌'s point - it's called an "earn-down" allowed under SBA. Structured similar to a seller note but has performance hurdles tied to it and if they are not met, then subtracted from principle for that period payment to seller. As ^redacted‌ mentions, will require a larger than "normal" earn-down/seller note and like all of this, requires good conversation and negotiation with seller. ^redacted‌, is familiar with how to structure.

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