When structuring a transaction, there is a delicate balance to strike between a vendor’s desire to maximize their sale proceeds and a purchaser’s need to affirm the value of their investment. A purchaser’s concern may be about a concentration of goodwill being tied to the vendor or a lack of financing available to complete the transaction at the proposed transaction price. A vendor may be worried about their succession or retirement planning. By closing the transaction, the parties can however generate shared value. Below, we walk through strategies for how vendors and purchasers can strike a balance, find common ground and mutually benefit from closing a deal.
Vendor Financing: Often a vendor may agree to finance the difference in perceived value by entering into a vendor financing arrangement, which can help close the goodwill gap and act as a capital buffer for the purchaser. Under a vendor financing arrangement, the vendor and purchaser enter into a loan agreement, where that loan is subordinated to bank financing, and the details of which (i.e. repayment period, interest rate, and loan amount) are negotiated between the parties. The benefit of this arrangement is the vendor has a continued interest in the business to ensure the loan is repaid, thus keeping their goodwill close to the business, and for both parties, the necessary capital is available to close the deal.
Retaining Equity: An equity roll serves as another method by which a purchaser and vendor can address a difference of opinion over the valuation of a business. Particularly in cases which require lender financing, an equity roll, where the vendor retains equity in the business being sold, is sometimes perceived by lenders (and purchasers) as a way to reduce the risk of a loss of goodwill by keeping the vendor involved with the business. Consequently, this arrangement allows the purchaser to be more flexible with regard to price/valuation. It also provides the vendor with a true up mechanism on value, and potential up-side in the event the business demonstrates strong performance.
Earn-Out: An earn-out mechanism is a practical strategy that allows a vendor to bet on the future success of the business and be compensated accordingly within the confines of the measurable targets for the business to achieve. An earn-out can be a win-win for both parties if the targets are reached with pre-determined risk that if the targets are not reached, the vendor will not receive additional compensation. The main benefit of an earn-out is that it is a low-risk strategy for a purchaser but a high-risk, high-reward strategy for a vendor that aligns the parties around the continued success of the business.
The above process can be simplified by engaging a mergers and acquisitions firm, including the services of a chartered business valuator. This is a typical method to produce an independent valuation of the business. When structuring a transaction, objective professionals can help close the gap between concepts of value of the vendor and purchaser, as well as provide real-time data and market information as it relates to industry and market trends. Such professionals may implement a number of methods to value the business including earnings-based, market-based, and asset-based methods. Hiring a professional can be a reliable strategy for small to medium-sized private businesses to resolve vendor and purchaser valuation disputes.
Finding common ground on the valuation of a business between a vendor and purchaser can make or break a deal. The above strategies are ways to achieve common ground on the valuation of the business and may help to move the parties toward the ultimate goal of closing the deal.
We at Keyser Mason Ball, LLP are experienced at drafting the appropriate legal documentation to structure the purchase or sale of the business. If you have any questions regarding this or any aspect of your business, please do not hesitate to get in touch with us at 905.276.0431 or email@example.com. We are here to help.
This article is provided for general information purposes and should not be considered a legal opinion. Clients are advised to obtain legal advice on their specific situations.