Welcome to the World of Deferred Payments
Deferred payments can be your golden ticket to acquiring that charming business down the street. They can also help you sell your entrepreneurial dream on the right terms.
Put simply, a deferred payment is a financing arrangement where part of the purchase price is paid later. It’s ideal when a buyer doesn’t have full funding upfront. It’s also useful where value needs time to transfer, or where there’s extra risk in the deal.
Smart negotiators keep these options in their back pocket.
Why Use Deferred Payments?
Deferred payments help bridge funding gaps. They reduce risk for buyers. They can also increase the total sale price for sellers.
However, structure is everything. The wrong setup can create tension, confusion, or even disputes. The right setup can align incentives and create a win-win outcome.
There are three main flavours of deferred payments.
1. Vendor Finance
Vendor finance follows the simple “pay some now, pay some later” model.
Imagine you’re selling a business for $3 million. The buyer pays $2.5 million at settlement. The remaining $500,000 is paid over the next year.
This approach is common and relatively straightforward. But sellers must protect themselves. If the business turns into a pumpkin after handover, you still want your money.
Strong legal protections are critical. Security arrangements, guarantees, and clear repayment terms should never be optional.
2. Milestone-Based Payments
Milestone payments tie part of the price to specific achievements.
The buyer pays in full only once certain assets, contracts, or revenue targets transfer successfully. In sectors like accounting, part of the price may depend on clients staying on after the sale.
This structure shares risk. Buyers gain confidence that value will transfer as promised. Sellers gain comfort that payment follows performance.
Clarity is essential. Every milestone must be measurable. Every trigger must be documented. A solid contract does the heavy lifting here.
3. Earnouts (It’s Not as Scary as It Sounds)
Earnouts link future payments to the business’s performance after the sale.
Think of it as the buyer’s insurance policy. If the business performs as expected, the seller receives additional payments. If it exceeds expectations, the seller can strike gold.
Earnouts often keep the seller involved for a transition period. This helps transfer knowledge and relationships. It can also smooth leadership changes.
But caution is vital. Future payments must be clearly defined. Performance metrics must be specific. Control over decision-making should be carefully addressed.
Ambiguity is where earnouts go wrong.
The Earnout Roller Coaster
Earnouts can be thrilling, helping sellers ensure their business(their legacy!) is in great hands and attracting more buyers. However, every ride has its dips!
Earnouts generally require the seller to stick around, which can be challenging, to say the least if you don’t get along – or you’re not taking to your new role where you’re no longer calling the shots or regarded as top dog.
There’s a great story from one of our friends on The Deal Room podcast, who threw in the towel early due to the unexpected twirls of a new management style.
Most of the stumbling blocks, though, are more about the way the deal is structured, and occasionally, the intriguing characters involved. Remember, transitioning from being the head honcho to essentially an employee can feel like a bunny in a shark tank. But fear not, every earnout can be tailored to fit everyone like a glove.
Hungry for more? Grab your very own copy of Buy Grow Exit on our website. Dive into the magical world of deferred payments and make the smart choice that suits your adventure. You’ve got this!
