Seller Earnout Examples with an SBA Loan

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November 28, 2023

by a searcher in Boca Raton, FL, USA

While I understand you can’t have a direct earnout arrangement with an SBA loan, I'm curious about alternative structures that effectively mimic an earnout. I've come across a few creative approaches:

1) Implementing a conditional consulting agreement. If the business achieves a certain goal (like hitting a GP target) within the first 12 months, the previous owner is engaged as a consultant at a predetermined rate for the following year. 2) Crafting a conditional seller financing clause where a portion of the seller financing is forgiven/wiped out if the business fails to meet certain benchmarks in the first year.

I would love to hear what other approaches have been successfully employed in this context.

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Reply by a searcher
from University of North Carolina at Chapel Hill in Raleigh, NC, USA
#2 is the play - from what I understand the most common benchmark is top line revenue because it's hard to get all parties (SBA included) comfortable with anything margin or expense related because new ownership controls decisions related to cost (which could theoretically be 'gamed'). Also doesn't have to be limited to year 1 only I don't believe - could be any negotiated duration.

#1 I don't believe is 'allowed' under SBA rules because they don't permit seller to be around after first 12 mos. Now does that mean truly all sellers are 100% out after 12 mos in every SBA deal that's closed ever - definitely not.

A possible door #3 is to go the route of the seller retaining equity in the business (<20% if they don't want to sign a PG) post-close which could allow for more upside growth in the business.
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Reply by an intermediary
from Clemson University in Raleigh, NC, USA
To my knowledge, Steve Mariani (Diamond Financial Services) and I completed the first transaction with a "Forgivable Promissory Note" in February of###-###-#### Now commonly referred to as a 'Forgivable Seller Note'. The transaction was a large garden center which included the land and building. It was for a three-year term and included provisions for the maximum payment amount, sales floor, sales ceiling, interest rate, and the procedure for calculation of forgiveness. Perhaps most importantly, the APA also included three examples to minimize the potential for inconsistent interpretation.
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