In a perfect world, when owners decide to sell their business, a buyer will come forward and write a check for the full asking price. In the real world, this rarely happens. There are so many reasons why this rarely occurs. In this blog, I want to focus on one of the most important issues. [...]
In a perfect world, when owners decide to sell their business, a buyer will come forward and write a check for the full asking price. In the real world, this rarely happens. There are so many reasons why this rarely occurs. In this blog, I want to focus on one of the most important issues.
One of the biggest risks for a buyer is whether the business will survive without the seller’s presence, knowledge and relationships. I want to give you some actual examples of businesses I have both recently sold and am in the process of selling.
I have a client who wants to sell his insurance business. He has done a wonderful job creating and running his one man business. However, when selling his business he has a big problem. The only asset that he is selling is the relationships he has with his clients. You would think that very few buyers would be willing to take that risk. However, after listing the business for less than 2 months, I have already had over 300 inquiries. The challenge has been to bridge the gap between the business opportunities and the inherent risks of this type of transaction.
The key to selling the business is the Earn-Out structure. An Earn-Out is a contractual provision stating that the seller of a business is to obtain additional future compensation based on the business achieving certain future goals. In the insurance example, the buyer would pay 50% up front to the seller of the agreed offering price. After the 1st year, he would pay an additional 25% based on how much business is generated from his book of business during that year. After the 2nd year, he would pay the final 25% based on the business generated from his book of business for that year.
This arrangement gives the seller a vested interest in making sure that his clients stay with the new owner. It also takes away some of the risk to the buyer. If some of the clients do not transfer over, then the buyer will end up paying less for the business.
I recently sold 2 businesses where the buyers saw a great opportunity to make money but were buying businesses that they did not have any experience in. Once again, we structured the sales with an Earn-Out. This time the purpose was to make sure that the seller had a stake in the business while training the buyer. The seller realized that the better he trained the buyer, the more upside he had in the final price. The buyer liked the arrangement for that reason and also because it he could retain some of his capital and use for other purposes. The Earn-Out in both of these cases was structured with equity. The buyers bought 80% of their respective businesses with a contract to buy the remaining 20% over a 2 year period. The final result was a win for the buyer and a win for the seller.
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