Seller Retained Equity Buyout

May 16, 2024

by a searcher in Meridian, ID, USA

Sellers are retaining 10% equity of the business and we're funding the rest with a bank loan (non-SBA, but similar). What are some potential ways we could structure buying out the equity?
Our loan is a 10 year loan, but the sellers want to be bought out in 5.

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Reply by a lender
in Stuart, FL, USA

Hi David, this is a loaded question. It's like any other vocation in life 20% of the people are really good at what they do and 80% of the people, we all wonder how they get out of bed every day. It's no different in the business brokerage world. As somebody who trains the largest business brokerage firm in the world on SBA lending, I can tell you that a very good business broker can indeed help with the transaction tremendously. Conversely a bad business broker with a chip on his shoulder can get in the way and destroy the deal for everybody. Unfortunately, sometimes you don't have the ability to choose who you want to work with if the seller has already chosen a business broker that's going to be problematic. When we do deals, we usually orchestrate the entire deal and just have the business brokers get documents for us for the most part. The good ones that work with us don't even mind because they know we'll take care of it and close it because we have over a 98% closing ratio. It's all about structuring the deal from the beginning and making sure everybody's on the same page. One of the biggest problems I do see with business brokers, especially if they are transactional brokers, is they just stay away from doing more work than they have to. So, when it comes time to discuss the A/R, A/P, WIP, working capital, seller note structure, and costs associated with the business acquisition outside of the loan, a lot of them just become a ghost with no input which can really make and unfair deal for more than one party. I am still licensed as a business broker although I do not work in that capacity anymore. If you have any additional questions and want some blatantly honest feedback, give me a shout, I’d be happy to help in any way i can.

Reply by a searcher
from The University of Chicago in Chicago, IL, USA

One thought to consider would be to negotiate valuation up front for any future equity purchase to avoid later negotiation. If you include a call option is to make the valuation some step-up from the initial valuation - this can be huge if you expect to grow the business a lot. For example, have a call option to purchase their 10% rollover equity at an EV of 120% (or whatever percentage you'd like) of the EV at close. This way, if you grow LTM EBITDA to 150% today's value, you are not paying a fixed EBITDA multiple on that substantially higher EBITDA.

I hear the folks who are saying it should be at FMV and that is one path that could work. However, the problem for the seller is that you are in control and the FMV at the time of your call on the 10% is out of their control. And if FMV is significantly lower than 120% of today's EV, do you want to exercise that call anyway? For the avoidance of doubt, it probably makes sense not to agree to a fixed higher EV if it is a put option (I may try to avoid a put option at all unless the seller is adamant).

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