Deal structures for semi-absentee business

January 17, 2022

by a searcher from The University of Michigan - Stephen M. Ross School of Business in Chicago, IL, USA

Hi All,

I am looking to buy a small service business where I will be dependent on the seller who has agreed to stay on as a manager. There are risks to her leaving, at least in the first year. Is there a deal structure that has been successful to keep a seller on?

Thanks

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Reply by a searcher
from The University of Michigan in 1075 Gills Dr, Orlando, FL 32824, USA

^redacted‌ I had a similar situation and used an SBA 7a loan. You cannot have an earnout with SBA but you can have a seller's note that has hurdles that need to be met to get paid out, which is what I did. You can structure the note to offset some of your risk. For example, you could require the seller to remain involved full-time for 1 year and you could also have revenue hurdles, client retention hurdles, etc. The SBA does not allow the seller to be an employee for more than a year so you won't be able to put anything in writing that would require the seller to stay on for more than a year. The bank is also highly unlikely to confirm that the seller has left after a year.

Reply by a searcher
from University of Virginia in Atlanta, GA, USA

Don't do SBA financing. The best instruments to keep her involved and her incentives aligned will violate the letter of the SBA 7(a) rules even if some bankers are willing to step into gray areas. Do a mix of (1) seller note, (2) rolled, non-voting equity, (3) performance-based compensation with a lot of upside opportunity, and (4) focus initial operational changes to give her the working life she wants (e.g., an assistant to take some tasks off her plate, digital tools to make her life easier, etc.). In addition to all that you should make sure your personal relationship with her is strong, and you should hedge by transitioning the business into something that could survive even if she left you high and dry as soon as you can.

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