Financing the Sale of your Business: Dealing with a Purchase Price Gap

October 23, 2014

Seller paper, SBA financing and buyer cash often comprise the three major components of a business purchase. However, what happens when a really good buyer (as perceived by the seller) wants to buy the business, but a gap persists between what the buyer is willing to pay and what the seller will take?

Under the above scenario (which is fairly common), a business broker or other facilitator must get creative in conceiving other sources of payments to the seller which are palatable to the buyer. Let’s discuss some to them…

  1. Employment Contract/Consulting Agreement: Something which buyers are often willing to pay for, this written agreement provides access for the buyer to discuss future business ideas and/or address problems with the seller. It generally does not require specific duties of the seller but it is very explicit on compensation; the buyer simply reaches out to the seller on an as-needed basis.  
  2. Non-compete: While many deals include a non-compete clause as part of the purchase price, often a buyer will pay for a longer, more favorable non-compete than what is typically included in the deal agreement.
  3. Earn out: This component is an add-on to the deal and specifies subsequent payments over a period of years (generally less than five) to the seller if certain benchmarks (often sales targets or profit levels) are achieved by the business under the buyer’s management.
  4. “Second bite of the apple”: More sophisticated buyers realize that an excellent way to close a purchase price gap is to offer the seller a minority interest in the new entity at a “bargain price”. There is usually an exit plan for the seller’s new minority position, which could pay him a significant sum if the business does well in the post-sale years.
  5. Sales rep agreement: Often a major or favorite account will be assigned to the seller with the understanding that for limited responsibility (i.e. mainly functioning as a goodwill ambassador) the seller will be compensated with a certain percentage of sales from such an account for a period of a few years.

On “difficult deals”, often a combination of the above five non-traditional payments can account for 25% of the total purchase price. While most have favorable income tax consequences to the buyer, some can be structured to be neutral to the seller. It is always a good idea to confer with a professional knowledgeable with respect to how the tax code treats various deal components.

Contributed by Michael Greengard, Praxis Business Brokers.

Through the Michigan Chamber’s partnership with Praxis, we can guide you through a step-by-step process of the complexities, all while maintaining complete confidentiality. To learn more about valuing and/or selling your business, please contact Michael at mgreengard@praxisbusinessbrokers.com or 616-588-4640.