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Understand deal structures

Selling a business is completely different from any other kind of transaction. Since every business is completely unique, and every buyer has completely different circumstances, deal structures vary widely. When you talk to a buyer, you might run into some of these possibilities.

First, and most common, is cash–as they say, cash is king. The more cash involved in the deal, the lower the price will be. In some cases, the deal will involve a holdback. This is a portion of the cash that sits in escrow, usually for a year, to cover any unforeseen or unreasonable costs that arise from any failures on the seller’s part to disclose problems with the business.

The next most frequent facet of deal structures is seller financing, where the buyer pays for a portion of the business over the years after purchase. The downside for buyers is that they won’t see any money for a while, and they’re paying for the business out of its profits. This approach will likely increase the total valuation, but there’s always a risk that something will happen to the business or buyer that prevents the seller from collecting the revenue.

Another common method is for the buyer to pay for a consulting agreement. While it’s typical to include some amount of hours over the first three months for transition assistance, buyers can also set up consulting agreements to keep original team members on retainer for longer.

Buyers will frequently also tie a portion of the sale to a non-compete provision. This is usually a negligible amount that’s contingent on you not creating a competitive product within a set period of time.

As mentioned above, holdbacks are another strategy to mitigate risk for the buyer. With a holdback, a certain amount of cash will be put into escrow as a contingency for problems that may not have been disclosed. Or, if the day after a sale a customer initiates a lawsuit, the buyer would be able to pay the legal fees out of the holdback.

But there’s much more than financial considerations with different deal structures. Some will mean more involvement from you; some will increase or decrease risk for either you or the buyer. More often than not, higher multiples or valuations will lead to more complex deals.

Almost all aspects of a deal structure will have different tax implications, and those will vary even more by country. Long story short: talk to your accountant to make sure you understand the full implications of selling your business. I discussed potential offers with our accountant every couple of weeks so we could counter-offer.

With Sifter, we decided to walk away from our first deal on closing day because the buyer claimed to have discovered an issue the night before closing. The deal structure had become complex and tenuous enough that we no longer felt comfortable selling it to this particular buyer. The buyer’s claim felt like a last-second effort to shift risk to us, believing we were in too deep to walk away. It wasn’t easy, but abandoning the deal was definitely the right thing to do.

We ended up selling a few months later in a drastically simpler all-cash deal. The total valuation was lower because it was all-cash, but the process was smoother and we felt much better about the new owner. As a result, we got an intimate look at both a complex deal structure and a very simple one.

In most cases, buyers are looking to purchase the assets rather than the business entity. This means you’ll retain a shell of a company after you sell your application. It’s a subtle distinction, but it’s worth noting. You’ll still have an entity to shut down when everything is done and dusted.

Generally speaking, there’s a large cost and overhead to complex deal structures. Risk is shifted around. Obligations and responsibilities are created. This all leads to increased costs with accountants and lawyers. In our case, the initial offer and deal structure became disproportionately complex relative to the deal value. Our final deal was much simpler because there was an inherent level of trust and mutual respect. Our second offer was more than 10% lower than the initial offer, but it was worth every penny. Sometimes that’s just how it shakes out.

What I Learned Selling A Software Business. Patrick McKenzie (aka patio11) details the process of selling his small software business, Bingo Card Creator. He talks about valuations, the transactions, and all of the ups and downs of going through the process.

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