Bridging the Price Gap Between Buyer and Seller

When a buyer and seller agree on nearly everything except price, the gap can often be closed through deal structure rather than a price concession. Common tools include seller notes, earnouts, leasing real estate or equipment instead of selling it, phased purchases of the company, royalties, and carving certain assets out of the sale. Each shifts value or risk between the parties in a way that can make the numbers work for both.

Why all-cash deals are harder to get

Most sellers would prefer to be paid in full at closing. In middle market transactions, though, some seller financing is often part of the deal, and sellers who insist on all cash frequently accept a lower price than they could have achieved with a different structure.

Even buyers who can pay all cash often prefer that the seller leave part of the price in the deal through a note or an earnout. Deferred payments give the buyer some protection if the business turns out to be different from how it was represented.

Earnouts: paying for future performance

An earnout pays the seller additional money if the business hits defined performance targets after closing. Buyers like to point out that if the business is as good as represented, the seller has nothing to fear.

Sellers have a reasonable response. They know the business performs under their management, but they have no control over how the buyer will run it. Having carried the risk of ownership for years, many sellers are reluctant to stay at risk with someone else in charge.

Earnouts work best in specific situations. Suppose a company has spent several years and significant money developing a new product that launches just as the business is sold. The parties can agree on a price for the existing business and add an earnout that pays the seller if the new product's sales reach agreed levels. The seller is compensated for the investment, and the buyer pays for results only when they materialize.

Other ways to close the price gap

Lease the real estate instead of selling it

If the real estate was part of the original deal, the seller can keep it and lease it to the buyer. That removes the property's value from the purchase price. In some cases the buyer may accept a higher rent in exchange for paying less for goodwill. The same approach can work for machinery and equipment, which the seller can retain and lease back.

Sell the company in stages

The buyer can acquire less than 100% of the company at closing, with the right to buy the remaining interest later under a predetermined formula. As an illustration, a buyer might acquire 70% at closing with options to buy the rest in annual increments. The seller continues to share in profits and receives a price for the remaining stake based on later results. The seller may also negotiate a "put," which requires the buyer to purchase the remaining interest by a certain date.

Share ownership of a fast-growing division

When one part of the business is growing much faster than the rest, the parties can place it in a separate entity and share its ownership until the main transaction is paid off. This lets the seller participate in growth they believe the price does not reflect.

Structure a royalty

A royalty pays the seller a percentage of revenue, gross margin, EBIT, or EBITDA for a defined period. Royalties are often simpler to structure and monitor than earnouts.

Carve out certain assets

Vehicles, non-operating real estate, and other assets that are not essential to the business can be excluded from the sale, which lowers the purchase price without changing the value of the operating business.

What it takes to structure a creative deal

None of these approaches solves every pricing disagreement, but they often move the conversation forward. Structuring a transaction that satisfies both parties takes time, experience, and creativity from the advisors involved, along with good tax and legal advice on each option.

If you are negotiating the sale of a business in Southern California and the parties are stuck on price, contact BusinessQuest Brokers to discuss structuring options.

Frequently asked questions

What is an earnout in a business sale?

An earnout is a portion of the purchase price paid after closing, only if the business reaches agreed performance targets such as revenue or earnings levels.

Why do buyers want sellers to finance part of the price?

A seller note or earnout keeps the seller invested in the business's success after closing and gives the buyer some protection if the business was misrepresented.

Is a royalty easier than an earnout?

Often, yes. Royalties based on revenue or gross margin are usually easier to calculate and verify than earnout targets.