M&A Monday: The Myth of the Absentee Seller

How to handle a Seller who is deeply involved in the business. A Family Office client is moving forward with a deal under LOI, and last week, they called me and said, Eli, it has become pretty clear the Seller is not just a key contributor to the business, but he is the business. What do I do? Seller involvement is a common issue in sub-$3 m EBITDA deals. I see it so often that I started calling it the Myth of the Absentee Seller. I advise clients to always assume the Seller is more engaged than they represent – sometimes Sellers simply do not realize how critical they are. Buying a business like this will fall apart after closing without the Seller engaged. Here is my game plan when dealing with an involved Seller: 1. Rethink the Deal. First, is the deal still worth it, and at what price? You have to factor in the cost of hiring or stepping into the business yourself as the CEO. Often, it takes more than one person to take on the Seller’s role. Once you decide you want to move forward, you should consider implementing some of the tools below. I view these in terms of carrots and sticks. A. Transition Services. The Seller should be required to provide transition services to make sure the business transitions properly. I tell Sellers that after closing, the only thing that should change is the digits in their bank account – come into work the next day as if nothing has changed (at least until Buyer has their footing). Two key points: (i) this must be a covenant in the purchase agreement or otherwise an indemnifiable provision, (ii) the market is that up to 3 months is generally included in the purchase price, up to a year is required, paid per hour. B. Holdback/Escrow. This is a stick. Consider withholding part of the purchase price to ensure the business is properly transitioned. C. Deferred Consideration (i.e., earnout, forgivable promissory note). Deferred Consideration is a great tool for ensuring that the business maintains it targets after closing. Be aware, sellers do not love this (they think they will never see this money), and it creates complications in the closing process. (SBA 7A note: earn-outs are not allowed; forgivable notes are allowed as long as the target is based on historical business performance.) D. Rollover Equity. The Seller rolling part of their purchase price into equity is one of the best ways to ensure the Seller is assisting with the transition and helping the business to be successful. Rollover is win-win. It is tax deferred for a Seller and could allow Seller to have a second exit. For Buyer, it reduces their equity burden, gets an industry-knowledgeable partner, and (usually) an equity class subordinate to preferred investors. This can get complex and there are lots of ways to structure rollover equity with different economic impacts. (SBA 7A Note: Rollover requires a seller to personally guarantee the whole SBA loan for two years). E. Strong Restrictive Covenants. Lastly, another stick. Be extra careful about non-compete, non-solicit, non-disparage, and confidentiality. My client decided to move forward with the deal, but put in place some of these carrots and sticks. We had a frank conversation with the seller, he understood us, and agreed to collaborate. We found some win-win solutions and are proceeding to closing.