The Purchase Price (Part 1)
The Purchase Price (Part 1)
From the seller’s perspective, the purchase price is (somewhat obviously) key.
It’s not just bigger is better—although bigger never hurt. Also important is cash at close, the certainty with which the seller will receive the full purchase price, and potential seller upside.
Let’s look at some examples.
Example 1 – 100% Cash at Close
Let’s say you want to buy a $5,000,000 company, and will rely on a mix of investor equity and SBA financing. Your sources of capital may look as follows:
The purchase price is equal to the SBA loan amount plus the equity that you’re bringing to the table (investor + sponsor equity, where sponsor is just a term for searchers who take on investors).
In this example, the seller will receive the full $5,000,000 at close.
This is ideal from the seller’s standpoint. The seller is guaranteed to get 100% of the purchase price if the deal closes.
In your LOI, you could describe this structure as follows:
The purchase price for the assets will be $5,000,000, subject to adjustment, and payable in cash at the closing of the transaction.
But few SMB deals are structured 100% cash at close. That would be extremely risky for the buyer.
Instead, most SMB deals include an element of seller financing—a loan from the seller to the buyer in the form of a promissory note.
Example 2 – Cash at Close, Seller Note
Seller notes are one of the best risk mitigation tools in the buyer’s toolbox.
A seller note puts the seller’s skin in the game. The seller will have a vested interest in successfully transitioning the business (if the business fails, the seller is unlikely to recoup the loan). In addition, the buyer has recourse against future indemnified losses, which can be offset against the amount owed on the note.
More on seller financing in a future post. For now, just recognize that it is normal for sellers to finance between 10-15% of the purchase price, sometimes more.
Let’s return to our sources of capital.
The cash at close has dropped to $4,500,000, an amount equal to the SBA loan plus the equity less the seller note. This is slightly less favorable from the seller’s perspective, but very common. So common in fact:
Be wary of those sellers that resist seller financing.
In your LOI, you could describe this structure as follows:
The purchase price for the assets will be $5,000,000, subject to adjustment, and payable as follows:
(1) $4,500,000 payable in cash at the closing of the transaction; and
(2) $500,000 payable in the form of a promissory note, executed by Buyer in favor of Seller, bearing interest at 7% per annum, with a term of five years. For the first two years of the term, the note will be on full standby, with Buyer making neither principal nor interest payments. The principal of the note will amortize over six years.
The above language describes the note being on full-standby for two years (no interest or principal payments). This is normal in SBA deals, where the buyer may want the note to count towards his or her equity injection. Partial standby is also an option (interest only payments).
The interest rate, term, standby periods if (any), and amortization schedule are all up for negotiation.
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In Part 2, we’ll review escrows and holdbacks, in addition to earnouts and seller note forgivability. We’ll also cover rollovers.