Deal Structure and Terms
One of the most misunderstood parts of buying a business is the importance of deal structure. The structure of a deal is as or more important than the price paid for the business. Ultimately, deal structure is used to create a fair playing field between the buyer and seller.
Imagine you want to buy a business that has one customer who represents about half of all the revenue and has a close personal relationship with the seller. If you pay the full purchase price and the seller leaves, things might not turn out too well.
But what if you agree to pay two-thirds of the purchase price upfront and the other third after a one-year transition in which the seller works closely with you to transition the relationship with the customer? If the seller fails to transition the relationship, then you don’t have any obligation to pay the last third of the purchase price. This sort of structure mitigates the risk for the purchaser, and as long as the seller does as agreed, he or she receives the full price of the business.
Vendor Financing, Earnouts, & Other Variables
Some of the more common deal structure variables include:
- Partial vendor financing
- Non-compete agreement by the seller
- Transition/training commitment by the seller (often starting off full-time and then diminishing to an ad-hoc contract)
- Part of the purchase price being paid based on expected future revenue (earnout)
- Vendor financing and earnouts supported by some form of security, including personal guarantees, cross-corporate guarantees, shares of the corporation being purchased, general security agreements, or other security relating to a specific asset
- Monies held in trust while certain transition/training items are completed
Every deal will have a number of terms associated with it. For more complex deals, these terms can cover dozens of pages. Some examples of very common terms are:
- Amount of deposit and when it becomes non-refundable
- Price the buyer is willing to pay for the business
- When and how the price will be paid
- Non-compete agreement
- When the deal closes
- Amount of working capital to be included in the sale
- Fixed assets included in the sale
- Vendor financing
- When will it be repaid?
- What interest will it bear?
- What is the security?
- Seller remuneration, if seller is to work with buyer
- Deliverables for the buyer and seller
Warranties & Representations
In the final agreement (usually drafted by your lawyer) there will be a number of warranties and representations as part of the deal terms. For the most part, these warranties and representations will be standard for almost all deals. Some of these will be:
- The seller has the right to sell the assets/shares of the corporation.
- There are no lawsuits that are ongoing or have been threatened.
- The financial statements presented are fair and accurate.
- The corporation has paid all taxes.
- There have been no stock options issued or other pledges against the shares (in a share sale).
- The assets are free and clear of all liens and encumbrances.
- The seller has the right to enter into the contemplated sale.
- The seller will execute all documentation needed to complete the sale.
Of course, each transaction will include other warranties and representations that are unique to it.