There are many ways to sell your business and in fact, we can go as far as to say that each deal is unique. But what potential options do you need to be aware of and what are the benefits behind each type of deal.
There is of course an outright sale, which is when the full agreed price for the sale of the business is paid upon completion. If you have a limited company, this can be an asset or share sale, which is explained in my article. This usually occurs with the sale of smaller businesses.
This is when the sale price is paid in staged payments. This usually involves a lump sum upon completion (usually at least 50%) and the remainder to be paid over an agreed period of time usually over 1-3 years with payments made monthly. If you are selling your business in this way, a well drafted sales agreement is required as protection in case of default. You would also want personal guarantees in place and want to see regular financial updates to ensure the business is running smoothly and to help foresee any future issues. It is usually accompanied by a consultancy period during the payment period, which gives the Buyer further security and is beneficial for staff, customers and suppliers.
Your business may be sold to a larger company and the Acquirer may offer you a share of their organisation as part of the deal, and again this may involve a part up front cash payment, or a 100% equity deal. You will then become a part of their business either continuing to trade as you are or amalgamated with the Acquirer. Each deal is unique but the majority of the payment for your business will be in equity of the Acquiring company. There may be options to purchase your equity share by the Acquirer later, and it will normally involve you continuing in the business. In such cases, its important to ensure that company cultures and exit strategies are aligned.
This is where part or all of the sale price is dependent on future earnings. The gap between your expectations and a cash strapped or skeptical buyer in the value of your company is caused by the expected future growth and financial performance and this therefore is a way of proving value. This way of selling your company is intended to bridge that valuation gap. Earn outs allow sellers to potentially facilitate a higher price and offer the buyer additional financing options to pay for the acquisition with future profits of the acquired business. It's become very prevalent in the current economic climate.
The deal can vary from anything such as a Buyer agreeing to pay 90% up front and you to retain 10% of your company or to pay on earn out over one year. It can even be a 50% initial payment, with the remainder over 5 years with the owner staying on to maximise profits.
As a seller, you need to have realistic expectations of the businesses performance over the next 3-5 years. It can act as incentive based compensation for you to continue on as management as it will align interests of maximising profit. It can also be argued that it can lead to a smoother transition.
Considerations for this include:
1. Defining the acquired business
If it operates as a separate, stand alone or independent subsidiary then measuring performance should be straightforward. It becomes more complicated if your business becomes part of the Buyers existing business. The parties will then have to find a way of segregating and measuring the performance of the business. From the Buyer perspective, they will need to ensure that your structural concerns do not affect the buyers intention to integrate the business. The Buyer will also want to ensure that future revenues are not inflated artificially by support or infrastructure offered by the Buyer’s business. The agreed definition should include; the product or service, geographic regions, client type, and price, whether or not expansion of the acquired company will count towards earn out and how next generation products and services will be treated, also how will common customers be treated.
2. The performance matrix to be used?
Sellers often want to use turnover as this cannot be as easily manipulated by the buyer. On the other hand Buyers will want to use net profit as it shows a more complete picture of the business. As a compromise, usually accounting measurements are agreed and an EBITDA is defined.
3. Earn out period and payment structure
The period should be agreed. A period that's too short may distort the performance of the business. A seller and management may sacrifice the long-term interests of the business for short term gains. Buyers may prefer a shorter earn out period as control of the business is restricted.
4. Allocation of control between the Buyer and the Seller during the earn out period and the level of support the Seller will give.
It is often in the Sellers interest during the earn out period to prevent the Buyer from making significant changes to the business such as discounting products, reducing sales and marketing personnel or shifting revenue or costs from one business to another.
So, if you are considering an earn out:
Keep the length of the agreement as short as possible
Make sure you have control
Ensure that incentives are in place
Keep key personnel