Structuring a deal using seller financing that makes sense for both parties?
December 10, 2024
by a searcher in Las Vegas, NV, USA
Hi Folks, I am contemplating a future meeting with a potential target, seller, who is interested in financing the deal using seller financing. I would like to read your experiences using this vehicle to close the gap between their expectations and mines. Where can I learn on how to structure a deal that makes sense for both parties?
from University of Pennsylvania in Denver, CO, USA
- Seller note: pretty straight forward; If you go down this route I would try and write the terms of the seller note so that it does not have a personal guarantee
- Forgivable seller note: I've typically seen these written with conditions based on the companies performance after the first year (e.g. seller note is forgivable if revenue does not exceed $X after 1 year). I've often seen forgivable seller notes with sliding scales (e.g. if revenue exceeds $2M after the first year then the seller's note will be 100% of the agreed upon value, if revenue is between $1.5M and $2M then the seller's note will be 75% of the agreed upon value, ...)
- Earnouts: these typically will favor the buyer the most. From personal experience, I would avoid trying to draft earnouts in a way that you plan on gaming (e.g. the seller has a much more optimistic POV regarding the companies future performance than you do) - this may seem like a way to make the purchase price sound a lot higher than (you believe) it will be but it's also more likely to result in future disputes which can translate into lengthy and expensive lawsuits.
Some things to consider:
- Seller financing structure and terms are more limited if you get an SBA loan (e.g. the term of the seller note must be equal to or greater than the term on the SBA loan).
- An aspect to consider from the seller's point-of-view is whether they are planning to stay on and for how long post acquisition. For example, if the seller is only planning on spending 3 months to transition the business over and then is leaving, their ability to influence the company's future performance and thereby hit the earnout milestones is fairly limited.
- Earnouts seem like the best way to align seller and buyer long-term goals but there is a catch: when milestones are not hit and therefore earnouts are not paid this can lead to disputes and possibly lengthy expensive lawsuits.
- For forgivable seller notes and earnouts complicated structures are more likely to lead to disputes (i.e. lawsuits) than simple structures. Metrics that more closely correlated to business profitability may seem like ideal candidates for structuring an earnout but note that these also tend to invite more disputes as they are easier to game. For example, EBITDA is more highly correlated to profitability than revenue but it's much easier for the seller to argue that the buyer acted in bad faith and incurred atypical expenses to avoid having to pay an earnout.
from Babson College in Bethesda, MD, USA