Your forgiveness trigger is measuring the wrong number

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by an investor from University of Virginia
in Tampa, FL, USA

2h ago

Your forgiveness trigger is measuring the wrong number

Contingent & forgivable seller notes are underused as downside protection, but the trigger design is where most of them fail. Common version ties forgiveness to revenue. If Rev drops below a threshold, part of the note goes away. Clean, easy to measure, easy for both sides to agree on. Here's the problem. It's usually not the risk. Margin is. A biz can hold revenue perfectly flat while the owner's departure costs you the pricing discipline, vendor relationships, or labor efficiency that made the earnings work. You hit every revenue trigger and still bought something that doesn't perform. Tying it to GM or SDE is harder to negotiate. Sellers resist, and advisors resist harder, because it puts post close operating performance partly in the buyer's hands. That objection is fair and worth engaging on rather than steamrolling. Measurement periods, defined add-back treatment, and a cap on the contingent portion all help. Curious how others here have handled the trigger question, and whether anyone has landed on language that sellers actually accept.

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reply by a searcher 12m ago
in Orlando, FL, USA

> 5. Seller notes are already a form of downside protection. > The bigger question may be whether you're overengineering the contingent portion. A properly structured seller note with meaningful subordination, a reasonable amortization period, and a portion at risk may provide cleaner protection than trying to create a complicated post-close earnings test. @redacted‌ hey brett, could you expand on this a bit more? the way I see it, on it's own (and I haven't written or read a real seller note!), the seller note is not really protection _for the buyer_. it doesnt disappear when things collapse. yes, it might be deferred if there's not enough earnings to cover it and the SBA/senior note (so short term assist for a bad period). and yes, it might disappear in bankruptcy. but none of those actually _protect_ the buyer, from what I can see, against a materially different behaving business for the buyer than it was for the seller. the seller note is _senior lender_ downside protection. not buyer protection. the forgivable parts - which all have some sort of measurements as @redacted‌ mentions - are the only buyer protections, and those aren't automatic parts of every seller note.....are they?

reply by a searcher 3m ago
in Orlando, FL, USA

@redacted‌ thanks sam - a clarification request, because I've seen gross margin commonly representing two concepts: one, gross margin $ == gross profit [gross revenue minus COGS] two, gross margin % == [GP/GR] which one are you suggesting to measure? if you mean gross margin %, would you measure both revenue and % - since % could stay flat and revenue collapse. and gross profit could go up, while revenue goes down (so GM% goes up) And I'd love to see some sample language around how you would define this type of performance note.