When buying or selling a business, the purchase price is often the main focus of negotiations. However, the payment terms are equally crucial and can significantly impact both parties involved. Here’s an overview of the key considerations and strategies for agreeing on payment terms in business sales from Richard Rodriguez & Skeith partner, Kathryn Turpin.
The Importance of Payment Terms
While finalizing the purchase price is essential, the way this price is paid can be just as critical. Sellers typically prefer receiving 100% cash at closing, which guarantees immediate liquidity.
However, this often requires buyers to secure external financing, which can be both time-consuming and expensive.
On the other hand, buyers usually prefer to pay a small cash down payment, such as 10%, and finance the remainder through a promissory note over several years.
This minimizes their immediate financial burden but is less attractive to sellers, who bear the risk of default.
Strategies for Agreement
To bridge the gap between the buyer’s and seller’s preferences, various strategies can be employed:
1. Earn-Out Consideration
One effective method is the earn-out consideration, where the buyer agrees to pay the seller additional amounts based on the business’s performance post-closing. This can be measured by metrics such as revenues, EBITDA thresholds, or customer and employee retention rates.
Example Scenario:
- Remaining purchase price: $1 million
- Buyer offers: $850,000 promissory note + up to $300,000 based on performance metrics over three years
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This approach benefits both parties. Buyers are reassured they won’t overpay for an underperforming business, while sellers have the potential to earn more if the business thrives.
2. Performance Metrics
When structuring an earn-out, it’s crucial to define clear performance metrics. These could include:
- Revenue Targets: Payments are contingent on the business achieving specific revenue levels.
- EBITDA Thresholds: Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a standard measure of a business’s operational performance.
- Customer/Employee Retention: Ensuring a stable customer base and workforce can be critical for ongoing success.
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3. Seller Involvement
Earn-out arrangements are particularly effective if the seller remains involved in the business post-sale. Sellers providing transition services or continuing as employees can help ensure the business meets its performance targets, aligning both parties’ interests.
Negotiating payment terms requires careful consideration and a willingness to find mutually beneficial solutions. Earn-out considerations, performance metrics, and ongoing seller involvement can all contribute to a successful transaction.
If you’re planning to buy or sell a business, Richards Rodriguez & Skeith is ready to assist you in navigating these legal complexities, with an entire team dedicated to corporate and transactional services. With the right approach, both buyers and sellers can achieve their financial and operational goals.
Contact us today to learn how we can guide you with your business sale or acquisition.
