Hi Reader Buying a Business: Tips for Protecting Your InvestmentBuying a successful business is still the best way to leave the rat race and write your own ticket. But it's not without risk. One major risk is underperformance. The best way to set your purchase price is by reviewing the business’s past performance. Problem is, if business declines—whether due to faulty data or other factors like economic downturn—you could end up in a tight spot. Luckily, there are powerful deal techniques to protect you while offering upside growth. Today, I’ll share how to structure them, when to use them, and how to convince sellers to agree. Why Don’t More Buyers Use Protective Techniques?Many buyers shy away from these techniques. Why? Four main reasons:
Don’t worry. These techniques are 100% SBA-compliant (though some lenders may have their own guidelines). Hypothetical DealRoofing contractor in Texas. Historic financials:
Listed price: $3.5M YTD 2024 financials are trending to meet or beat 2023. The business is highly dependent on weather and constrained by supply-chain and labor. It’s the largest roofing contractor in the region with both residential and commercial clients. You see potential but worry 2023 was an anomaly (post-COVID bump) and future profitability might decline. Step 1: Consider the Seller’s MotivationsBefore diving into techniques, keep the seller’s interests in mind:
Understanding these will help you structure and communicate your protective techniques without offending the seller. Step 2: Protective Techniques1. Forgivable Seller NoteA forgivable seller note is a portion of the seller note that’s subject to permanent forgiveness if the business underperforms. It requires:
Example:
Summary:
2. Seller Note with Revenue StabilizationFor sellers who balk at forgiveness, use a repayment “pause” or “full standby” for revenue stabilization. Conduct Revenue Reviews every 6 months for 2 years. If TTM Gross Revenue drops below a threshold (e.g., 5-10% below Benchmark), the note goes on full standby for 6 months. Example:
Summary:
3. Performance EscrowA performance escrow sets aside part of the purchase price with a third-party escrow agent. Funds are released based on performance metrics. Example:
Summary:
Step 3: Bringing it All TogetherYou now have three techniques to mitigate downside performance:
You can mix and match these techniques based on your risk appetite and deal specifics. Understanding these techniques helps you structure better deals, ensuring your financial interests are protected post-closing. Questions? Send me an email or join in the convo on X (@lawyer4SMBs). Otherwise, happy hunting! Eric Hsu, M&A Lawyer Publisher, Freedom through Acquisition Newsletter DISCLAIMER: I am a lawyer but not your lawyer (unless we so happen to be working a deal together pursuant to a written engagement agreement). This newsletter is for educational and informational purposes only and nothing in this or any other issues is intended as legal or financial advice and cannot be relied on as such. Do your own diligence and consult with your own lawyer or financial advisor before taking any action on your deals. Nothing in this newsletter is intended to solicit your business in any way and should not be interpreted in any way as legal advertising. This newsletter is wholly owned and operated by FTA Resources, LLC |
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