Welcome to the (quick guide) world of deferred payments – these can be your golden ticket to acquiring that charming business down the street, or, if you’re on the flip side, selling your entrepreneurial dream.
Deferred payments are a financing arrangement ideal for businesses where a buyer hasn’t got full financing upfront, or which might need a little more time to transfer value, or where there’s a little extra risk involved for the buyer in the deal. Here’s our short sharp take on what they are and why you should have them in your back pocket while negotiating a business sale.
Deferred payments come in three different flavours:
1. Vendor Finance
This is the common ‘pay some now, pay some later’ approach. Let’s say you’re selling a business for a cool $3 million. The buyer may shell out $2.5 million at the time of sale, and then pay out the remaining $500,000 over the next year. This method is as quite common, but beware sellers – you need to have protections in place to ensure the remaining cash lands safely in your pocket, even if the business turns into a pumpkin after changing hands.
2. Milestone-based payments
Here, the buyer and seller share the excitement of the ride together. The buyer only pays in full once all assets or contracts have been successfully transferred across. In some sectors, like accounting, it’s common to delay part of the payment to ensure the clients stick around. For sellers, this is a chance to ensure the buyer will pay and for the buyer, they get to ensure the suggested (and agreed) targets will be met. A solid contract really comes into play here.
3. The ‘Earnout (It’s not as scary as it sounds!)
This is the buyer’s insurance policy to make sure the business’s value is fully transferred and realised once in their hands. In this case, the buyer shares the risk and the seller could strike gold if they’re willing to work together to ensure the post-sale business is just as successful as years prior. This option might even keep the seller around for the long run – where their expertise and experience can be leveraged before they exit, under this arrangement, they’re passing the baton of control over a few years before leaving to ensure their business wisdom is transferred. But sellers, be wary of future payments if these aren’t REALLY clear in your contracts – they can lead to less-than-ideal scenarios.
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!
