Price versus terms: why a deal's structure matters

When people talk about buying a business, they talk about the price. But the price is one number in a deal with many parts. How much is paid at closing, how much later, what happens if the business stumbles, when the deal closes and how long the owner stays all change what the deal is worth to each side.

That's good news for buyers. When you and an owner can't agree on the number, you can often agree on the structure.

What "terms" means

The terms are everything about how the price gets paid and what comes with it:

• Cash at closing. How much the owner receives on the day the sale closes.
• Seller financing. Part of the price paid later, as a loan from the owner to you, called a seller note.
• An earnout. Part of the price paid only if the business hits targets after closing.
• Timing. How long you'll take to check the company, and when you'll close.
• Transition. How long the owner stays to help, doing what, and for what pay.
• What's included. Equipment, vehicles, inventory, the name, the phone number and money owed by customers.

A dollar later isn't a dollar now

To an owner, money paid at closing is certain. Money paid over five years depends on you running the business well, and the owner has to wait for it. That's why many owners will take a lower price for more cash at closing, and expect a higher one when they're asked to wait.

What matters most depends on why they're selling. An owner retiring to pay off a house may care most about cash at closing. An owner leaving for health reasons may care most about speed. An owner who built the company over 30 years may care about the headline number, or about their employees. Why owners sell goes through how each reason changes what they want from a buyer.

The timing of payments can also change the owner's tax bill. That's a question for their accountant, and a reason to ask what they're hoping for before you assume.

One company, three offers

Say you're looking at a hypothetical HVAC company with owner earnings (profit plus what the owner pays themselves, before loan payments and taxes) of $300,000 a year. The owner is asking $1 million. Your math says it's worth about $900,000, or about 3 times a year's owner earnings. You need a $100,000 salary, and you're using an SBA loan.

Some ground rules for SBA purchase loans. Under the SBA's lending rules, when you buy a whole business you must put in at least 10% of the project's cost. We'll measure it against the price; because the project includes some costs beyond the price, your lender's figure may be a little higher. A seller note can count toward up to half of that, but only if it's on full standby: no payments of principal or interest for the life of the SBA loan. Interest can build up and be paid after the bank is repaid. We'll also assume:

• closing costs of about 4 cents per dollar of price;
• a 10-year bank loan where every dollar borrowed costs about 16 cents a year;
• a lender who wants earnings after your salary to be at least 1.25 times all the yearly loan payments, including any seller note you're paying.

The three offers:

• Offer A: $900,000, all paid at closing.
• Offer B: the full $1 million, with $150,000 of it as a seller note paid over five years with interest, roughly $35,000 a year.
• Offer C: $900,000, with $45,000 of it as a seller note on full standby.

	Offer A	Offer B	Offer C
Price	$900,000	$1,000,000	$900,000
Owner receives at closing	$900,000	$850,000	$855,000
Owner receives later	nothing	$150,000 over 5 years, plus interest	$45,000 after the bank is repaid, plus any interest
Your cash, including closing costs	about $126,000	about $140,000	about $81,000
Bank loan	$810,000	$750,000	$810,000
Your yearly payments	about $130,000	about $155,000	about $130,000
Left after your salary, compared with payments	about 1.5 times	about 1.3 times	about 1.5 times

Look at what each one does:

• Offer A gives the owner the most money on closing day and the cleanest break. It costs you a fair amount of cash, but leaves room in the payments.
• Offer B gives the owner the price they asked for. In exchange, they get less at closing and wait five years for the rest. You pay more in total and need more cash, and your payments come close to the lender's limit. A slow year would pinch. In its favor, an owner who is still owed money has a real reason to help you succeed.
• Offer C gives the owner slightly less at closing and a long wait for the last $45,000, roughly the 10-year life of the bank loan. In return, it cuts the cash you need by about $45,000. Many owners won't want to wait that long, but some will, especially if they want a particular buyer to succeed.

None of these is the right answer. The right answer is the one that fits what this owner needs and what you can carry.

Earnouts: paying for a future nobody can prove

An earnout pays the owner more later if the business hits targets, such as revenue or keeping a big customer. It can settle an honest disagreement: the owner believes last year's jump in sales will last, and you aren't sure.

If you're buying with an SBA 7(a) loan, though, seller earnouts aren't allowed under the same SBA rules. The SBA does allow the reverse, a buyer rebate: the owner pays you back part of the price if the business falls short of agreed targets. That money first goes toward paying down the loan. Ask your lender how they'd handle one before you propose it.

Transition: the owner's time has a value

An owner who stays three months to introduce you to customers and employees is worth more to you than one who hands you the keys and leaves. Put the details in the offer: how long, roughly how many hours a week, what they'll focus on and how they'll be paid.

With an SBA loan, the owner generally can't stay on as an employee or officer after the sale, but the company can hire them as a consultant for a limited time. Ask your lender for the current limit, because the SBA updates these rules.

The owner's wishes matter here too. Some want to leave quickly. Others want to stay involved, and worry about being pushed out. What owners worry about covers how to talk about it honestly.

Timing: speed and certainty are worth money

A clean offer with financing already lined up can beat a higher offer full of conditions. The owner may have heard from buyers before who never followed through. Showing you can actually close is part of what you're offering.

Timing can also be part of the deal itself. A seasonal owner might prefer to close after the busy season and collect its profits. You might want to own the company before the busy season so you learn it at full speed. Either can be traded for something else.

How to use this in your next conversation

1. Ask before you offer. "What matters most to you: the total price, the money at closing, the timing, or how your people are treated?" The answer tells you where to give and where to hold.
2. Build two or three versions. Price each one with your real cash and the salary you need, and check every version against the lender's 1.25 test.
3. Explain the trade-off out loud. "We can do $900,000 at closing, or closer to your number if part of it is paid over time." Owners appreciate seeing the choices.
4. Get help before you sign. An accountant can explain the tax side for you, an attorney should draft the terms, and your lender should confirm what the SBA rules allow.

The best deals are often the ones where each side gets what it cares about most, and gives up something it cares about less.