For those that are new to the idea of buying or selling businesses, there are always questions. Many newcomers believe that buying a business is much like buying a house. The business is appraised based on what neighboring businesses sell for, the buyer puts down 20% and the bank funds the other 80%. The seller gets 100% cash at close and the property changes hands.
The reality is that small business transactions are much more nuanced than this and they can often include a few different components.
So what do I need to consider when structuring an acquisition
When looking to buy a business you’ll need to find a way to make sure that:
- You have access to enough capital in order to close the deal
- You are finding ways to address any risk factors involved in the business transfer
- Your interests as the buyers are well aligned with the interests of the sellers when at the closing table.
Once you have analyzed the business, gotten comfortable with the operations, and believe that you have reached reasonable terms with the seller, it is time to structure a deal that will help accomplish the above factors.
A holdback is when a portion of the initial purchase price is not paid out to the seller for a set period of time, or until a certain threshold is reached. This could mean that once the business reaches $1M in sales post-close, the seller gets the final 20% of his payment.
You may ask the seller to finance a portion of the purchase price for you. In essence, the seller will be acting as your banker. This means that you will be paying a nominal interest and debt payment to the seller until the business is paid off.
Profit-Sharing and Royalties
Giving the seller of the business a portion of the future cash flow or revenue of the business can help sweeten the deal and compensate them for their continued support of the business.
This is most often done when the business is being sold to a larger entity that has the resources to bring the business to new heights. If you are able to pitch the seller on your expertise in the sector and how you will grow the business, they may be willing to take a small portion of the compensation as profit sharing or a royalty.
Asset vs. Equity Transactions
In the world of buying and selling small businesses, the parties have the choice to either make a transaction for the business shares/equity or sell the business assets.
Asset sales are typically preferred by buyers because they have the ability to pick and choose what assets they want to be included in the deal and they are not acquiring any of the business liabilities. In other words, if the business owes back taxes…that won’t be your responsibility as the buyer.
Sellers typically prefer to sell equity due to the clean structure (one entity changing hands) and because of the favorable tax treatment that equity sales get.
Finding a deal that works for everyone
Being a buyer of a small business can be scary. In many cases, it is your life’s savings that you are parting with. It is prudent to make sure you understand the business that you are getting into and do plenty of research on the seller and their representatives to make sure you are engaging in a fair deal.
While it is typical for sellers to want 100% cash at close for their business, most sellers of businesses over $500K have been prepped for the fact that there will be some contingencies and deferred payment in the final contract.
As a buyer, you should be aware that many times your offer is not the only one available. In addition, many sellers will continue to run their business for years until the right offer appears. You will need to have some skin in the game and put your hard-earned money into the deal.