How should I credit a recent increase in sales while negotiating this LOI? - Searchfunder

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by a searcher from Ivey Business School at Western University
in Scarborough, Ontario, Canada

2h ago

How should I credit a recent increase in sales while negotiating this LOI?

Hi all, I've submitted an EOI and then an LOI to a firm that has most recent FY revenue of about $5M and EBITDA of about $1.25M. Over the past several months, the owner has ramped up their sales effort (they were doing ZERO outbound sales and marketing before), and revenue has increased substantially, and the expectation is that EBITDA would be increasing as well. The seller would like to see some credit for that growth in my offer, which I based on the previous year's EBITDA number (which was similar to a few years ago, with an uptick in between that then came back down to their baseline level). I wouldn't agree to base my offer fully on TTM EBITDA, but I was thinking I'd say that during due diligence we'd agree on a number at some point in between the last FY EBITDA and the TTM EBITDA (adjusted), with the expectation that it might end up at something like $1.4M, and I and my QofE firm would need to be satisfied that it's sustainable. Any suggestions/reactions on whether this approach is reasonable? Or other suggestions on how to handle this kind of situation? Would you offer any credit for a recent increase in sales? Thanks, Kamal

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reply by a professional 43m ago
from University of New Brunswick in Toronto, ON, Canada

In my view, wanting some credit for sales growth is normal, and not wanting to pay a full multiple on a few months of sales growth (not proven sustainable yet) is also reasonable. However, I would not suggest leaving your offer price to be 'agreed during due diligence'. This would build a second negotiation into the deal at the point where the Seller is anchored on TTM and you are incurring deal costs on the due diligence. In my experience, an open-ended agreement to agree is riskier for the Buyer and generally leads to deal friction at a later stage. I can think of these 3 options that can be negotiated at the LOI stage. (1) Agree on a formula for blended EBITDA. The Offer Price = Your Multiple × A Defined Weighting (e.g. 50/50) of FY and QofE adjusted TTM EBITDA, possibly with a floor and a cap. This way the seller sees how they get credit for the increased sales and you are not seen to be retrading later. (2) Base price plus contingent payment where you price your current offer at close on $1.25M EBITDA, then pay for the growth only if it proven to be sustainable. For example, pay a multiple on EBITDA above $1.25M over the 12 to 24 months after close. You can tie it to revenue or gross profit as that avoids disputes over costs you control post-acquisition. This way the Seller shares the increased sales sustainability risk, and (3) You pay lower multiple on the incremental increase in EBITDA due to increased sales such as a full multiple on the $1.25M baseline EBITDA and a reduced one (e.g. 50%) on the incremental EBITDA. This reduces the sustainability risk as the incremental increase in EBITDA has only months of history rather than years as with baseline EBITDA. Since earnings have increased and came back to baseline before, I would lean towards a contingent payment (Option 2). Two things I would also look into are (1) The cost of the sales growth and make sure the marketing and sales spend is fully reflected in the TTM figures and not capitalized, deferred or added back, and (2) Working capital because business growth usually needs more receivables and inventory, so the working capital peg should reflect the increased business.

reply by a lender 26m ago
in Falmouth, MA, USA

I'd put together a contingent note. Would be careful with the wording and would include sufficient downside protection in the event that the growth is just an anomaly. Happy to have a confidential chat. DM me.

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