Valuation of business with 100% seller note
August 16, 2023
by a searcher in San Francisco, CA, USA
Hello all
I am currently exploring a business opportunity where the seller has expressed a willingness to provide a significant portion of the financing (30%). The business exhibits a noteworthy customer concentration of 20%, with a client who share a personal rapport with the seller. Seller has agreed to stay on a management. role to ensure smooth transfer. Wonder how should I structure the seller note ? I would like to tie it it to retention and performance of the account or business in general.
My CPA has been looking into the books, he feels business is priced a bit high ~30k more , I am wondering if I should go back and negotiate the price down and risk the trust relationship with the seller. Seller has even offered to carry even a larger note should SBA 7a falls short. Given the seller's longstanding presence in the community and intimate knowledge of the business, I'm considering the prospect of tapping into their network and connections to fuel the growth of the business—perhaps even incorporating this into the seller note.
There is an intriguing alternative on the table: the potential for a 100% financing arrangement, with the flexibility to choose between an annual balloon payment or a monthly annuity payment structure spread over 120 months.
In light of these considerations, I'm pondering the value of engaging an independent valuation firm. Does the potential benefit outweigh the associated costs?
Appreciate thoughts and comments. Thanks in advance.
from Southwestern University in Houston, TX, USA
As to the customer concentration, I would absolutely make an earn out of the same percentage of the sales price as the percentage of revenue that the big company brings in. Especially with the seller saying for awhile (agree with ^redacted here - don't expect a long, full-time engagement), make the earn out contingent on a similar or higher level of revenue from this most important customer.
As to structure of the debt, if the 100% financing balloon note pencils and you're not giving away the farm, what would you do with the "extra money" (ie the difference between what the SBA loan would cost and what the 100% note costs)? If it's just pocketing the money, probably not worth worrying about. But if you've got specific growth initiatives you can invest in, now it might make sense.
in United States
- I don’t think you should try to change the price just because your CPA thinks the business is overpriced. If they found something you were unaware of that may be different. But if you put in an LOI and everything is checking out, it would be really poor form to try to rework the deal.
- if there are concentration issues, I think you should try to limit your risk by adjusting the seller note to deal with it. An earnout might work, but not if you are doing an SBA loan (they don’t want the price potentially going up after they’ve made the loan). See, for example, https://www.searchfunder.com/post/how-to-bridge-a-purchase-price-gap.
- I’m not sure why you would hire a valuation firm at this time. You may need to for an SBA loan, but if it is to help you think about deal structure I don’t think that will be their focus.