Business Deal Structures: All Cash,
Earn Out, Seller Carry Back
Common Deal Structures When Selling A Business. There are several ways to structure a deal when selling a business. Business value is determined in a number of ways. It often differs from buyer to buyer. Understanding deal structures can be the difference between selling and not selling. Deal structure depends on the market for business acquisitions. In a buyer’s market, a seller needs to be more open to creative deal structures. In a seller’s market, a seller can be more particular about the deal they accept.
Regardless of market, the characteristics of a business will often dictate the price and terms. For example: a business which is overly dependent on the seller is more likely to require an earn out or seller financing. A business operating passively is more likely to be an all cash deal. A business sale can be accomplished through a variety of ways.
Here are the three main structures:
- All Cash Deal: Seller is paid full sales amount at closing
- Seller Carry Back / Seller Financing: Seller is paid by a note with the full sales price and interest paid over time
- Earn Out: Seller is paid sales price over time according to some business performance metric (i.e. revenue or gross profit)
Almost always, a business deal is a combination of structures.
All Cash Deals
In an all cash deal, the owner is paid the entire sales proceeds at closing. This is the simplest and least risky deal structure for the seller. In an all cash deal, the seller is owed no additional funds after closing. This happens most frequently when the buyer is able to finance the deal through a loan or equity financing. Because financing may be involved, the business needs to have clean, verifiable financials.
A cash deal also requires less energy from the seller after the sale. With cash deals, the owner’s proceeds aren’t dependent on the business’s performance post-sale. Because a cash deal seller is able to ‘walk away’ it can be a very appealing option. The appeal of all an cash deal can often lead a seller to accept a lower total sales price knowing there will be less risk for them. This can lead the seller to receive less total proceeds than an owner who accepts an owner-carry or earn-out.
Advantage and Disadvantages of All Cash Deal Structure
Seller Carry Back / Seller Financing
Another common deal structure is a seller carry back or seller financing with a note. The seller ‘becomes the bank’ in this scenario. This deal structure is common when a buyer does not have the full sales price in cash, the business is ineligible for bank financing, or the buyer does not qualify for financing.
This deal structure has more risk for the seller and seller often requires a higher sales price. The note can either come with a personal guarantee or use the business assets as collateral with a security agreement. In the event of default, the seller can pursue legal action against the buyer, but may end up owning the business again when it is over.
Advantage and Disadvantages of Seller Carry Back
Earn Out Deal Structure
The last common deal structure is the earn-out. An earn-out is similar to seller financing in that the seller will have some risk after the sale, but payments are based on business performance post-sale. An earn-out is typically based on a formula with a percentage of either revenue or gross profit paid out to the seller over a set period of time. It is not recommended to base an earn-out on profit because profit can be manipulated in small businesses by increases in owner payroll or owner’s discretionary expenses. Basing an earn-out on profit is only recommended if buyer and seller can agree to a very specific formula for how profit is to be calculated.
The earn-out is often used when a buyer feels a business has too much risk and needs to share that risk with the seller. If the business ends up performing as expected, the seller gets paid at or above the original sales price. If the business underperforms, the seller receives less than the original sales price. This often encourages the seller to stay involved in the success of the business post-sale.
Alternatively, an earn-out can be used when a seller expects significant increases in future revenue and wants to partake in the increase. This increase could be from a new large contract or large customer.
Advantage and Disadvantages of Earn Out
Understanding Deal Structures Can Lead To More Satisfied Parties
When selling a business there are several ways to structure a deal using the three structures listed above. Each structure has is advantages and disadvantages. As a seller or buyer of a business, understanding these structures will help you craft a deal that makes sense for your personal situation. Through understanding the goals of each party involved and potential risks, a little creativity in deal structure will often make for more satisfied parties in the long-run.