Phased Acquisition - How to structure/align incentives?

July 08, 2024

by a searcher from University of Colorado at Boulder - Leeds School of Business in Denver, CO, USA

Hi all - I'm a second time self-funded searcher working on proprietary search. I have come across a number of owners who have expressed interest (at varying degrees) of a phased transition. The specific owner I'm talking to now is a janitorial company. The owner is looking to have income/be a part of the company for the next 5 years. He has suggested the idea for me of: "a buy in, on going salary, commission, earn in ownership, purchase, then our exit."

I like the idea for a variety of reasons (no PG, less transitional risk, better work/life balance). That being said, I don't want to grow the company significantly and end up paying for my growth in 5 years. I know there's a variety of ways to structure this but having trouble putting all the pieces together.

Could anyone share examples of how this has been done in the past? Specific suggestions to align incentives fairly?

Reply by a professional
from University of New Brunswick in Saint John, New Brunswick, Canada

Hi Nick - you can pre-structure the earn-out economics similar to seller financing, and put in incentives for better performance and minimum performance metrics (ebitda, revenue, cash-flow). For example - you buy 51%, you set your control parameters (how major decisions are made, spending, etc), then you list out your option(s) to buy the rest of the shares including how the price will be set. The price could raise with time linearly, it could be higher if you trigger the buyout and lower if they trigger it, it could have a multiplier like outperforming projected EBITDA (or you could handle that part separately with an employment agreement). Most people think of an earn-out as "I buy X shares, and all else stays the same" but in reality you can set the price, the provisions for if/what dividends are paid out, and put any controls you want in place. The bonus of this approach is that you can get in for a few years then decide whether a) you want to buy the rest of the shares and keep the operator b) same as a but find a new operator c) sell your shares to another purchaser d) sell the entire company.

Reply by a professional
from University of Southern California in North Palm Beach, FL, USA

Lots of my clients have successfully done this. My father-in-law used the tactic (with my help) to sell his longstanding successful business.

Here’s a copy of my comment on another post that might be helpful here:
This topic alternates with another topic for the #1 reason people privately Zoom with me. Too much to say on this topic by merely posting comments. It takes an hour to personalize what each searcher needs to know, and do. Beware of snippets of tips. Generic insights are not enough; they can mislead searchers into self-defeating beliefs and actions.

Don’t underestimate the value in motivating owners to want to stay on. But know how to propose it and craft the terms for mutual benefit. Including having a street-smart provision(s) to cancel or modify the agreement(s) on the basis of what is occurring after the change of ownership, and beyond the transition of management.

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