Selling Your Business – Price vs. Terms

A key goal in selling your business is gaining maximum value for what you have built. There are a few significant considerations to keep in mind when you’ve reached this stage of the process.

Locating Qualified Business Buyers

Of greatest importance is (with the help of your advisor) to have found one or more strong buyers that have the financial ability and operational resources to acquire and run the business. Multiple buyers will present you with a variety of options on prices and terms. But even with a single buyer, knowing you have options can help you enhance the transaction value.

Creating Win-Win Situations with Business Sellers and Business Buyers

Another aspect to consider is that the deal should be structured in a way that takes into consideration the best interests of both the buyer and the seller, or as much of a “win-win” situation as possible. Negotiate important areas that are meaningful to you, but some give and take can help you get what is really important. Good buyers will understand and respect this approach. Finally, understand that the offer will almost always be a certain amount of cash at closing, with the remaining value consisting of terms that remain in place after closing. Less than one-third of deals are structured as all cash at closing. And all cash deals historically come in at least 20% lower than a combination of cash and terms. But even all cash deals will have important terms attached.

Given these realities, it is important that an owner understands that buyers will make an offer that is structured to give them the best opportunity to be successful from day one of ownership.

Some of the key terms normally included in offers are as follows:

  1. Seller Note– The seller carries a part of the total offer in the form of a note with interest, paid out over a certain number of years. Sellers will often reject this out of hand; however it is sometimes necessary and advantageous for business owners. If the buyer is getting third-party financing, the lender often requires the seller to hold some of the price. A seller note confirms to the buyer and the lender that the seller believes in the business and can lead to a higher price. Key considerations before agreeing to this are the amount of the down payment, security on the note, and the financial and operational level of the buyer.
  2. Non-Competes and Employment Agreements– The buyer can offer the seller an employment agreement ranging in time from a few months up to several years. Buyers realize that the owner knows the business best, has good relationships with employees, customers, and vendors, and therefore can provide important continuity after the sale. They will pay a salary and possibly benefits for this, which can be negotiated. Regarding non-competes, the buyer will want to be sure that, for a certain number of years following the owner’s exit, they will not start up a competitive business and take customers away. However, they can also be too restrictive and unduly limit the seller from pursuing other business opportunities.
  3. Taxes and Asset Allocations– Is the deal structured as a stock or asset sale? Stock deals are usually advantageous for sellers, however many buyers will not agree due to risk of assuming all prior liabilities of the business In an asset deal, different pieces of the business such as fixed assets, inventory, non-physical assets are taxed at different percentages. These allocations are often negotiated as they have major impacts on both the seller and buyer. Your tax advisor or business intermediary can explain the differences in more detail. Taking a seller note can stretch out the owner’s tax consequences so they have a lower tax liability in the year following the sale.
  4. Net Working Capital– This is basically the difference between the current assets and current liabilities of the business. In general terms, it is the cash in against the cash out that is available to operate the business day to day. Often times the buyer will include in an offer that a certain amount of working capital remains in the company so the business can continue running without interruption. Important considerations are the seasonality of working capital requirements and the buyers request versus the overall deal value.
  5. Tangible or Hard Assets– This normally includes equipment, machinery, and inventory. Buyers will look these items over in detail during the due diligence phase. Critical equipment that is in need of replacement or obsolete inventory could become issues for negotiation as they affect the buyer’s perception of value.
  6. Leasing Assets– If the buyer cannot or does not want to buy all the assets at closing, sometimes the seller can lease some assets in order to reduce the cash needed to close. It also gives the buyer a chance to pay from the performance of the business after the sale. This can happen in cases where a business has very expensive, underutilized equipment, or the business is generating poor cash flow. This can mitigate buyer risk, increase income to the seller, and possibly reduce taxes.
  7. Stock in the New Company– Some buyers will want the owner to remain an active part of the company and help it grow. Therefore they may structure stock in the new company as part of the compensation for the purchase. If the business continues to do well, the stock can be worth considerably more than the value at closing.
  8. Earn Outs– Earn outs are structured as possible pay outs in future time periods, based on the performance of the business. This is in addition to the original purchase price. In instances where the business may be in some distress or has a high potential upside, the buyer may offer an earn-out of some form that allows both buyer and seller to share in growth. It’s important in the agreement to determine how the earn out will be measured. Simpler is usually better, but it can be based on revenue, margin, or profit targets.

Above are some of the more common term options in typical business sale transactions, but many others are possible as each business and deal is unique. It’s important to be aware of these possibilities when selling your business. Your M&A advisor should have experience in the various aspects of structuring offers and working with buyers. They are the ones closest to each party, and will know what is most important to both seller and buyer. The advisors’ knowledge will bring added value to the process and to the business owner. And quite often, when there are multiple offers involved, the structure of the deal makes all the difference, not necessarily just the cash.

For more information, contact BMI Mergers & Acquisitions:
Offices: 610-777-7029 or 717-207-0722

Copyright 2012, Business Markets Inc., Thomas W. Kerchner, David K. Clark