THE Day is finally within sight. That is, the day you sell your business. It’s not here yet, but it’s getting closer and when you allow yourself to dream, you will wonder, “So how do I actually get paid?”
Most of us dream of a big lump sum when the exit day arrives, but this very rarely happens. A buyer wants to minimize her risk that future business results are not what was hoped for. Thus, she wants to pay as little upfront as possible. Instead, a buyer will typically pay you in one (or a combination) of these five ways:
Lump-Sum Payment
You want at least a portion of the sale price in a lump sum and that’s fine. While this approach may be the most appealing to you, there are two drawbacks. First, it might be tax inefficient. Second, it may provide the lowest total payment.
A Note You Carry
With this approach, the buyer makes regular monthly payments to you, including interest, over several years. This helps spread out the tax burden for you and provides a steady income stream. The downside is it takes time for the new buyer to pay off the note and this introduces risk for you. What happens if the new owner can’t make the business a success? What if the new owner defaults on payments?
If you’re considering a note as a part of your payment plan, you must perform detailed due diligence on the buyer to ensure she will be able to run your business and make payments. Additionally, you must ensure your business attorney writes the purchase/sale agreement with contingencies if the buyer fails to make a payment.
Earn-Out Agreement
Often, a buyer will make a purchase contingent on the business achieving certain financial targets or milestones after the sale. This aligns the interests of the buyer and you and may result in a higher purchase price. However, this also adds risk for you.
Through no fault of yours, the business may not reach the goals upon which you and the buyer agreed. As with a note used as part of the purchase price, you must make certain your business attorney creates an iron-clad purchase/sale agreement to protect your interests.
Equity in the Buying Company
If your business is large enough and the buyer is big enough, you might receive shares or an ownership stake in the buyer’s company along with a lump sum payment. This allows you to benefit from the future growth of the new entity, but again, introduces business risk in the final value you receive from your company. You must have a purchase/sale agreement that explicitly details terms and conditions.
Consulting Agreement
You could also agree to stay on as a consultant for a defined period, receiving compensation for your services. This can help ensure a smooth transition and provide additional income. If this is a route you take, you’ll need to spell out your role and duties clearly as part of the purchase/sale agreement.
Most business sales occur with a combination of these approaches. For example, a deal might include a lump-sum payment, an earn-out, and a consulting agreement. When I sold my business to two different buyers, I received a combination of payment methods including lump sum payments, a note with 60 installment payments and a five year earn-out.
Each of these methods has its own advantages and disadvantages, such as tax implications, risk levels, and your future involvement with the business. You need to collaborate with a financial advisor, business attorney, and accountant to structure the deal in a way that meets your goals AND the goals of the buyer.
Let Yourself Dream a Little:
Have you thought about how you would prefer to be paid out when you sell your business? What do you see as the best and least desirable approach? Please comment below. Also, if you have questions about these options, please include them below and I’ll be happy to answer them.
