Most sellers assume that when it comes time to negotiate, price is the most important question to hash out. While price is important, the other terms surrounding a deal are often the key determinants in whether a deal gets done.
Every buyer and seller of businesses has a wishlist of what they’d like to see happen in a transaction. Realistically, there isn’t much chance for both you and the buyer to get everything they want. Here are the items aside from price that you and the seller will need to hash out to come to terms.
Type of sale (stock vs asset) – An important decision with real implications for the amount of money that you’ll take home and the amount of money that may be held back in escrow after the transaction. Buyers will almost always pursue an asset sale to limit their liability. You may want one or the other based on the assets, tax basis, and transferability of contracts in your business. Discuss this at length with your CPA before moving forward with an LOI.
Seller financing – Some buyers will request that you, the seller, finance the sale of your business. This means you will get less money up front and receive the balance (with interest) over the life of the loan you extend to the seller. Depending on your level of confidence in the business and your desire to reduce the taxability of the transaction, you may accept. You and the buyer will need to work out the term of the loan, as well as interest rates and any collateral that will be available in case of default.
Working capital – Working capital is the capital used by your business to perform day-to-day operations. It includes payables, receivables, inventory, and cash. The amount of working capital left in the business at the sale will be negotiated and the final purchase price will increase or decrease based on the number you and the buyer arrive at. Sometimes working capital is left out and assumed to remain the property of the seller.
Earnout terms (optional) – An ‘earnout’ is an agreement you make with the buyer that modifies the final purchase price of the business depending upon the business’s performance for a designated time period after the sale. An example might be a $1 million payment up front, with another $500,000 payment if the business hits a certain revenue target over the 18 months after the sale closes. Earnouts are most typically seen in scenarios where the seller is transitioning with the business and plans to remain active to oversee operations for a period of time.
Transition terms – The amount of training and/or full-time work you’re willing to provide after the transaction takes place will often be a vital consideration for the buyer. If you are not willing to provide any real transition you should indicate this up front. You may also consider restricting your search to strategic or industry-specific buyer pools.
Licensing/permit requirements – Many businesses require city, state, or federal licenses to operate. Some buyers may already be licensed in your industry; others will not. This should be a priority when transition plans are being discussed.
Assets available for sale – Many small business owners co-mingle personal and business assets. You may, for example, own a truck in your business that you’d like to retain after the sale. Any assets used in business operations you’ll be excluding from the sale will need to be addressed with the buyer, who will likely assume all the business’s assets will be transferred.
Reps & Warranties – Representations and warranties are contingences put in place between the buyer and seller that protect each from any material misrepresentation that might occur in a transaction. They are attached to the purchase agreement and bind each party for a designated amount of time. An example might be the seller guaranteeing that the financial condition of the business as represented in financial statements and tax returns is true and correct.
Escrow terms – As a rule of thumb, 10-20% of every transaction is held in an escrow account for 18-24 months after the transaction closes to protect the buyer and cover any breach of reps & warranties. This amount is negotiable but industry standards are usually followed. Once the holdback period has expired, the funds are released to the seller.
Closing timeline – It is often in your interest as the seller to close a transaction as quickly as possible. Buyers, however, need to conduct thorough due diligence in your business to ensure the condition of the business is as you’ve described. There is almost always a happy compromise to be found here if everyone works expeditiously to produce and analyze documents related to the transaction.
These are some (but not all) of the key terms that need to be addressed in any small business transaction. Given the nuanced nature of each item, it’s easy to see why many businesses fail to sell or go through several potential buyers before closing a transaction. In our experience, the best way to keep a deal moving forward is to be transparent about your needs up front and be willing to compromise on items that are less important to you.