Feedback on proposed seller note forgiveness terms

April 25, 2024

by a searcher from Stanford University - Graduate School of Business in Salt Lake City, UT, USA

I'm under LOI to purchase a pool and spa maintenance and service business. For the first 4 months of 2024, they are 35% behind on revenue compared to the previous year, which is very strange, given that their July through Dec of of 2023 exceeded that of###-###-#### So up until February of this year, things looked great.

The LOI proposed a 20% seller note. My initial thought is delay any payments, essentially placing it on standby, for the first 12 months, spending an amount comparable to the seller note payments on marketing and sales, and then determining the final seller note amount after 12 months on a sliding scale. If 2023 revenue is matched, then the entire seller note will be paid. If, say revenue is only 75% or less of 2023 numbers the entire note is forgiven, and there will be a sliding scale in there. Essentially 20% of the seller note amount tied to every 5% increment between 75% and 100% of revenue target on a continuous basis.

I'm curious what other suggestions folks might have.

I've read some of the outstanding posts on this topic, but haven't seen anything quite like this proposed.

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Edit: Thank you everyone for the great input and suggestions. To add a little more commentary, current owners purchased in Feb/March of 2022 and then switched their operations software in March of 2023, so I really only have great job/customer data going back to April of last year.

I'm attaching a screenshot of the monthly comparison over the past two years. Note that the numbers have all been scaled by the same factor, so these are not actual numbers but again scaled, but relatively speaking, should illustrate what is going on. Also note that the current total of 2024 is a trailing twelve months total to compare to 2023.

As far as I can tell, service calls (repair) have been down in April of this year compared to last year. Last year also included a single large job that perhaps skewed financials upward. It of course still gives me pause. I'm getting it for a very decent multiple (well under 3x), but of course a 35% top line drop for the year could wipe out 50% or more of SDE.

This is very interesting from a timing standpoint. If I was closing on Feb 1, 2024, just 3 months ago, I would've felt so much better about the deal, when they seemed to be on the upswing from the previous year.

Reply by a professional
from University of Michigan in Detroit, MI, USA

Hi ^redacted‌, I echo Brad's comments above. Before negotiating the structure of a forgivable seller note (I'm assuming you are using SBA financing), try and get to the bottom of the issue. Thirty-five percent is a big drop and there is a limit to have much damage control you can do if the drop in revenue is indicative of a larger issue.

As for the seller note, you have a couple of different levers, as you identify. First, you could consider building in a payment holiday--more than just placing the note on standby in the beginning, you could have a trigger whereby payments are paused in the future if revenue drops below a certain threshold.

Second, again, as you state, you can have seller agree to forgive some of the note. The structure you propose is fine. But I would try and keep things simpler. The point is not just to reduce the purchase price but also to get seller to put his money where his mouth is. Settling on a fewer increments with larger $ drops may help up the stakes from seller's end.

As for the tax issue, forgivable seller notes can be structure so as to reflect a reduction in purchase price. But as with all things tax, seek the proper counsel. Make sure you partner with a law firm with an experienced tax attorney on the roster.

Happy to discuss further. Let me know if I can be of any help. Reach out here or by email at redacted

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I am not sure what type of financing you are looking to use, but if you are using SBA financing then you cannot do an earn out. The only way to make it work would be a seller note with forgiveness factored in. I have typically seen such seller notes have a reduction or forgiveness feature if certain metrics are not hit like revenues, EBITDA, etc. The only challenge you will is that if that seller note is set to go into repayment within the first year, then the Bank would need to count that payment against debt service. If you have it on standby for the first two years then the Bank would not need to count it against debt service, so if there is a drop in cash flow you can still get the deal qualified.

In general, I would be very concerned about a drop of 35% for a service company. This is substantial. Many pool and spa contracts are annual on-going contracts. You will want to find out what type of routes / customers they lost. They could have had a large churn at year-end, which means you are going to be buying a business producing significantly less revenue going forward. I have quite a bit of experience in this industry from a lending perspective. I would be more than happy to jump on a call to discuss further. You can reach me here or directly at redacted Good luck and sorry to hear you are running into this at this point in the game.

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