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The EXITpreneur’s Playbook — Part 2: Structuring the Deal
Joe Valley is the Co-owner and Director of Brokerage Services at Quiet Light, a business advisory firm that helps online entrepreneurs achieve amazing exits. Joe joined the firm after selling his own e-commerce business through Quiet Light in 2010. He has advisor expertise in all web-based niches, including SaaS, e-commerce, and content businesses.
In addition to being a frequent speaker and podcast guest himself, Joe is also the co-host of the Quiet Light Podcast.
Mark Daoust is the Founder, President, and CEO of Quiet Light. Since starting Quiet Light in 2007, Mark has guided dozens of entrepreneurs and small business owners through their exits.
Before his work at Quiet Light, Mark founded Site-Reference.com, an online publication with a subscriber base that he expanded to more than 220,000 members. Now, Mark is a well-known presenter and guest author, as well as the co-host of the Quiet Light Podcast.
Here’s a glimpse of what you’ll learn:
- Joe Valley breaks down the different variations of deal structures for a business transfer
- How do you guarantee payment with seller notes — and what can you do to mitigate payment risks over time?
- Joe’s tips for navigating holdbacks during cash deals
- The five points to focus on when structuring an earnout
- Mark Daoust’s advice for sellers: due diligence is a two-way street, so know your buyer!
- What are stability payments?
- How rolling equity can benefit both buyers and sellers during a transaction
- Joe shares his strategies for negotiating a working capital peg
- How to access three free chapters of The EXITpreneur’s Playbook right now
In this episode…
Are you ready to sell your business — but don’t quite know how to negotiate a deal? Do you want to ensure that you’re agreeing to a fair contract when buying or selling a company? If your answer is an enthusiastic “yes,” this episode of the Quiet Light Podcast is a must-listen!
There are many variations of deal structures to choose from when transferring a business, and each option is full of nuance that the average buyer or seller might not understand. So, how do you know which structure is right for you? Today, Joe Valley is here to break down the nuts and bolts of each deal structure — and share his tips for determining which option is best for your business transfer.
In this episode of the Quiet Light Podcast, Mark Daoust and Joe Valley explain everything you need to know about deal structures, as featured in Joe’s new book, The EXITpreneur’s Playbook. Listen in as Joe and Mark give an overview of each option and share their strategies for negotiating a profitable deal. Plus, they reveal how you can access an in-depth, written explanation of deal structures in The EXITpreneur’s Playbook today. Stay tuned!
Resources Mentioned in this episode
- Quiet Light
- Quiet Light on YouTube
- Joe Valley
- Joe’s email: [email protected]
- Mark Daoust
- Quiet Light Podcast email: [email protected]
- Free Chapters:
- The EXITpreneur’s Playbook Intro
- Chapter 3 – Valuation Overview
- Chapter 11 – Identify All Your Add-Backs
- Chapter 15 – Structuring the Deal
- Buy The Book:
- Buy The EXITpreneur’s Playbook on Amazon
- Helium 10
Sponsor for this episode…
This episode is brought to you by Quiet Light, a brokerage firm that wants to help you successfully sell your online business.
There is no wrong reason for selling your business. However, there is a right time and a right way. The team of leading entrepreneurs at Quiet Light wants to help you discover the right time and strategy for selling your business. By providing trustworthy advice, effective strategies, and honest valuations, your Quiet Light advisor isn’t your every-day broker—they’re your partner and friend through every phase of the exit planning process.
If you’re new to the prospect of buying and selling, Quiet Light is here to support you. Their plethora of top-notch resources will provide everything you need to know about when and how to buy or sell an online business. Quiet Light offers high-quality videos, articles, podcasts, and guides to help you make the best decision for your online business.
Not sure what your business is really worth? No worries. Quiet Light offers a free valuation and marketplace-ready assessment on their website. That’s right—this quick, easy, and free valuation has no strings attached. Knowing the true value of your business has never been easier!
What are you waiting for? Quiet Light is offering the best experience, strategies, and advice to make your exit successful. To learn more, go to quietlight.com, email [email protected], or call 800.746.5034 today.
Hi, folks, it’s the Quiet Light Podcast where we share relentlessly honest insights, actionable tips, and entrepreneurial stories that will help founders identify and reach their goals.
Mark Daoust 0:28
Alright, welcome back folks to the Quiet Light Podcast. Today we have part two of a discussion between Joe and myself about EXITpreneur. But as always, this episode is brought to you by Quiet Light, where we’ve been helping entrepreneurs prepare an exit their online businesses for the past 14 years. And we work with clients in the e commerce space, SaaS based content space, if it’s online. That is what we love to work with. Joe, I’m excited about the second part of the conversation today. I think last week, we talked a lot about just kind of why did you do this? Right? Why would you take on such a massive project as writing a book and launching a book? Which, for anyone that’s been through that process before they know it’s not a small undertaking it all today, I think it’d be better for us to get into some detail on what can people actually expect to see from this? Is this a lot of fluff a lot of stories? Or how needy do we get? So today? Let’s Let’s dig into some of that. Can you start out just by giving kind of an overview of the chapters maybe then we can dig into a chapter?
Joe Valley 1:35
Yeah. But and one of the things we’re doing in this podcast in the shownotes folks is we’re going to give you links to the introduction of the book into three separate chapters, that’ll be part of the show notes that you can, you can review it accessing if all you want to read about is deal structures, which we’re going to talk about today is one of the chapters read it, it’s yours, share it with anybody and everybody, you know, it’s it’s there for the taking. But the book itself does get very meaty, but it also it shares some stories as well, right? I’ve built bought and sold a combination of six different companies, and then involved in you know, hundreds of transactions myself, and I share some of those success stories and epic failures of individuals, I change names are necessary. And they use first names as well, sometimes
Mark Daoust 2:28
all the epic failures are mine, right? I pull the mask off current and past. That was a separate book, though. No. Fail a printer, right?
Joe Valley 2:41
I like that I’m gonna trademark now. And somebody else, somebody else already bought it. They heard you say it now that button, it’s gone, you guys gone. But we do get me and one of the things that you know, I think is really beneficial for both sides of the transaction both buy side and sell side is the chapter on deal structures and structuring the deal points. And so I wanted to dig into that because I know our audiences is for both buyers and sellers.
Mark Daoust 3:08
I will let’s get into that. Let’s get to that chapter. As far as structuring a deal, this is a big this is a big part right of the transaction. Because deals can be structured in a lot of different ways. There’s there’s a lot of different ways to cut up this this sort of transaction. So why don’t we get into how you break this chapter down?
Joe Valley 3:29
Okay, so there’s, there’s, as you say, there’s a lot of different points to it, right? It’s the variations of common deal structures are many. Its cash, seller notes, pullbacks, burnouts, stability payments, rolling equity work, working capital pegs, and then inventory notes if you’ve got a physical product business. And so we delve into each of those points in great detail in this particular chapter. Let’s just start out with cash, you would think that cash is simply cash, right? What’s the big deal, you’re buying a business for cash. But obviously, there’s variations to cash as well. For buyers that want to keep some of their cash for themselves, they can do a combination, instead of just I’m going to pay you a million dollars all cash, you can do cash plus a whole back cash plus a stability payment or seller note or an out equity row or some combination of all of the above. And for physical product companies. What we’re seeing is that the aggregators are being very, very good at doing a combination of all of the above. So let’s jump into it. We’re going to jump into some of the different things. The easiest one to focus in on is seller notes. Now, that’s something, Mark that we don’t see or historically haven’t seen that often on our transactions. Right.
Mark Daoust 4:49
Right. And when we do, it’s typically a pretty small minority of the of the deal. That’s right.
Joe Valley 4:55
That’s right. It’s generally you know, I think what I Talk about in the book is actually the largest seller known I personally have ever seen is 50%. And it was because the buyer and seller absolutely fell in love with each other. It was two women, they were both nearing retirement age one was buying the business, the other was selling the business and they got a long like long lost sisters. And it works very well for the seller to have a larger seller note that was going to pay out over time she did 50% for five years, which is rare. But it benefited her personally because she had a portfolio of investments that she wanted to let mature over the next five years. So in the sale of the business, this was going to give her income to live off of while that investment was growing. But you know, there’s there’s four deal, things I focus in on under selling notes. And one, you know, most people want to say no, I’m not ever going to do a seller note because I don’t trust my buyer, you’re going to get to know your buyer over time. And then you’ll be able to make that decision to say yes or no once you get to know them. But either way, you want to have that note, try to get that secured personally by the buyer and with the assets of the business. And this is where a good attorney, good contract attorney comes into play, you want to have them secured. Most business transactions that we’ve seen the seller notes again, it’s a smaller portion 25% or less normally, often just 10%. But that the length of that note is generally 12 to 36 months, that’s what’s most common. And there are exceptions that are longer, some that are much shorter, and that we’ll get into on the inventory node. As far as interest rates go. Lucky, you’re not a bank, but you should get paid. But when you do the math on $100,000, seller notes, when you go from 6% to 10%, it doesn’t really move the financial needle all that much. So you just need to do something that’s a fair and reasonable interest rate. You’re not a credit card company. But again, do the math on what it would be like, and you’ll find that, you know, you’re just not going to move the needle that much 100,000.
Mark Daoust 7:10
What sort of interest rates? Do you list interest rates in the book?
Joe Valley 7:15
It varies. So look on an SBA loan, you’re going to get anywhere, you know, we’ve seen anything, anything from five to 7%. I think if you could take the top side of that and add 8% it’s fair and reasonable. But you know, going to 16% or something like that, which I’ve seen some sellers want to do. It just doesn’t make sense. You know,
Mark Daoust 7:37
right now I know a lot of questions that sellers have on this topic of a seller note is how do I guarantee I get paid? And what happens if the person doesn’t pay me? Do you address that in the book at all? We do,
Joe Valley 7:50
we do. One of the things that you want to do in terms of setting up the payment structure is to make sure you’re not collecting a check or needing to go anywhere to get your money that it simply has to be automatic. When we drill into, you know, do you want to sleep at night and get paid on a monthly basis? Or do you want to get paid on a quarterly basis and sleep a little less, there are some seller notes where buyers are going to try to pay you on an annual basis. None of that makes any sense to me, it should be on a monthly basis basis. And it’s automatically drafted from their account. So there’s there’s no human error, and somebody has to remember to do it. But as far as guaranteeing you’re getting paid look life has no guarantees whatsoever. That’s where you’ve got to have a strong asset purchase agreement, that details to clear steps to be taken in the event the buyer defaults. And again, that’s where a good attorney comes in play. And you’ve got to have one, if you’re going to, you know Sell a Business for, I would say a quarter of a million and up. You should plan on spending anywhere from three to $10,000 in a good quality contract attorney that’s going to protect you in the event of something going wrong after the sale.
Mark Daoust 9:00
Yeah, absolutely. Absolutely. And I think there are some mechanisms you can do to protect yourself. I know Escrow.com offers like a domain holding escrow service, which can be used, it’s not used commonly, just because they’re they’re very expensive to use. And, you know, there are different things you can put in place. I did. I don’t know if you remember this, Joe, I did an interview years ago with the owner of brain hosts, who had sold his business to his business partners, and they ended up defaulting on payments, and he ended up getting the business back and we went through that journey. What was that? Like? How did he go through getting the business back? And there’s just two points that I want to bring up on this one. It was such a remarkable story, that somebody actually had to do this, that I thought it was worthy of an interview. Right? I didn’t want to let it slip because we don’t hear about it all that often. It doesn’t happen all that I mean it’s the exception rather than it really is the exception and then number two he It was able to get the business back and in good order. And you know, so it ended up working out and being a success story with some bumps along the way, which, you know, people hear that like, Oh my gosh, I don’t want to deal with that. Well, what is business business is nothing but hopefully a success story with some bumps along the way. That’s, that’s our journeys.
Joe Valley 10:18
That’s the thing, you know, when you’re selling your business, and you’re going to take any kind of seller note, you need that note to be small enough so that the cash is big enough so that the seller, I’m sorry, the buyer has a lot of skin in the game. They’re there, they’re desperately not wanting to fail, because they’re going to lose that entire amount that they gave you. And you’re probably still going to get the business back. I had a similar conversation with somebody who didn’t do a podcast. But a similar conversation with someone Cujo forgot to do, you forgot to mute his phone. Sorry, folks.
Mark Daoust 10:48
It’s It’s like we’re professional podcasters.
Joe Valley 10:51
I know, imagine that. Paul Anderson, one of our amazing advisors. So I was actually at an event for Helium 10, I forget the name of the event that they had, but someone had sold their business through the buyer use an SBA loan. So there was a lot of cash. In the game, there might have been a 20% seller note that time, which was really, really high. Generally, it’s 10% or less now. But the buyer defaulted on the SBA loan, the bank reached out to the seller and said, Hey, they defaulted. Would you take this over and owning 5050 with us, so he got, you know, 80% of the money for it, and then got the business back and own 50%. And he had grown it like crazy and was selling it again, and getting a second payday. So it wasn’t the path that he intended to go on. But it worked out pretty well for him financially.
Mark Daoust 11:50
That’s Yeah, that that that’s remarkable. Again, these are rare stories. And so when they, when we hear about them, it’s something that does stand out, you know, one other element and then we’ll move on to the next item in your list here that I just tried to explain to people with a seller note to not think about the entire seller note as being at risk, right? It’s all or no grows riskier, the further out it gets, right. So year one is typically not a super high risk note, year two might be just a slightly more risky than that, if you were if you had, for some odd reason, a 10 year note that 10th year is probably relatively high risk of defaulting. And so the thing about your seller note in that way as risk increasing over time, as opposed to the whole note being an equal amount of risk, which is where your point to monthly payments being preferable and possibly, you know, some people some people do like to structure balloon payments are not in favor those because that balloon payment is the most risky payment at the end of of a note. So yeah,
Joe Valley 12:51
yeah, and that’s why that’s why 12 to 36 month note is most common, because as Mark just said, the further further out you go, the higher the risk is of getting paid. These are businesses that people you know, grow and you know, eventually they make an investment they want to grow it and they eventually want to sell it in many cases. So 12 to 36 months is what’s most common and comfortable and and safest as well.
Mark Daoust 13:16
Alright, so we have cash, cash is pretty easy to understand it’s coming from somebody’s account or an SBA loan, but for the seller for the person selling, that’s money that goes in your bank account right away seller note is money that gets into your bank account over time. And again, people often use a combination of cash and a seller note or they want to use a combination, I should say, of cash and seller note and our history is That’s it? That’s all notes, minority portion. 15 20% 10% in that neighborhood.
Joe Valley 13:42
Yeah. And they’re, they’re generally reserved for larger deals. Right? Right. It’s, it’s, you’re not going to do a seller note generally on you know, 250 to $300,000 deal, we’ve got plenty of all cash buyers for that. And what they’ll implement is part number two here, which is moving on to holdbacks. The holdback is something that’s used most often with cash deals, and it’s tied to the training and transition period. So you know, most often we’ve got language in an asset purchase agreement that you know, talks about a training and transition period being for up to these keywords up to 40 hours over the first 90 days after closing. When you’re when you’re training and transitioning your business to the new owner, you’re not running an operating the business for them, you’re there to support them and help them as things come up, share your recipes and guide them through those. This holdback is again, use mostly for cash deals. And it’s a carrot for the seller to stick around and help during training and transition and buyers. Use that most often cash deals it gives buyers peace of mind that you’re going to be there to help them and is a carrot for you to stick around in the in the decade that I’ve been doing. This, there’s only been one holdback that has not been released. It was a special circumstance, I do talk about it in the book. Very, very odd, special circumstance. And it, it got released back to the buyer of the business, the seller never got because she disappeared off the face of the earth. She was Yeah, yeah. But But you know, you’re gonna see something like, you know, in the asset purchase agreement, or even starts in the letter of intent, something like language that would read a whole back equal to 10% of the purchase price will be held in escrow. And we’ll talk about that a sec, during a training and transition period of 90 days. And then really simple clear language with no milestones or anything other than that 90 day period, and up to 40 hours, you want to use up to in case, all the seller needs is three hours, you’re not obligated to commit to 40 hours, I’m sorry, the buyer. But generally 10% is about what we see, and we want it held in escrow. That way you’re not worried about the buyer paying you it’s just in escrow and is released in 90 days. Unless, you know, the buyer disputes something and you know, attorneys get involved in and again, I’ve seen that once in 10 years. Have you seen that? More than that one time that situation? We hit that with that?
Mark Daoust 16:16
Yeah, there’s a woman it’s been a few. Yeah, there’s been a few scenarios where or we’ve seen it really I can probably count on one hand maybe breaking in on the second hand. It the the training transition is the element that is often there. The other elements though, we’re in where I’ve seen disputes before have been post close realizations or discoveries of things that maybe were not disclosed properly before the deal. So maybe massive return of inventory that ends up being docked out or, or something else along those lines. Oftentimes with e commerce, businesses holdbacks are used for post closing adjustments that need to happen. And those are typically pretty minor. I’ve seen one case, Joe, this was actually really interesting. I won’t say who but we both know, the buyer on this one pretty well. Even one case where there was a hold back in order to benefit the seller from a tax standpoint, and that that whole back was actually requested by the seller in order to put some money out into the future in order to save things. But let me ask you, let me ask you just an objection. I know people on the sell side are thinking and for those that are on the buy side, I really want you to understand this point as to the psychology of the seller, when when a seller hears hold back, and the whole back is here as a carrot, they’re worried is this guy’s going to work me or this woman is going to work me and force me to work this business, I’m going to be constantly under pressure of oh my gosh, I’ve got $50,000 $100,000 hanging out here that I don’t get unless they give me a thumbs up is that the nature of this?
Joe Valley 17:57
It’s really not, it’s really not there’s the they don’t have to give you a thumbs up. It’s if the language is is is is written properly in the lol and the APA. It’s just an automatic released. Because again, it’s your training, it’s completely tied to the training and transition period and a language that is in there. And it’s simple language, the training transition is, you know, basically up to 40 hours over the first 90 days. And then the money is released. Simple as that. But it’s not it’s not complex. It needs to be there for you know, cash deals. So the seller sticks around because it gives the buyer a great deal of peace of mind. The peace of mind for the seller is the language and the way it’s written and the fact that it’s not in the sellers bank account. It’s in an escrow account with an attorney or through escrow.com or Zoom Escrow, which I talked about in the book Shakil S. Prasla and Shawn A. Hussain have launched a company called zoomescrow.com. And if you knew that, or No,
Mark Daoust 19:01
I did not. But yeah, I want to emphasize this point, because this is the this is the key to a whole back being really effective. And kind of Alain, the fear on the seller side of all, I need to win their approval in order to get this money holding the funds in escrow. It’s not in that buyers bank account, the buyer does not control those funds. So the only mechanism that they have to be able to get those funds back is by filing an objection to releasing the funds and that doesn’t automatically get the funds back that starts a process in which they have to make a case and for why those funds should be back. And the arbitrary initially, is really just the buyer and the seller. Right? And so, if you ask me, have I seen more cases? Yes, I’ve seen more cases, again, maybe probably one hand, maybe two hands, the number of cases or 1000s of deals that we’ve done. But when I see that happening, what the result is usually a week of conversations and then a resolution because nobody wants to go there. Nobody wants to go to that fight. It’s you. It’s it usually isn’t a fight. There’s usually if there’s a reason to file an objection, there’s usually actually a reason to do it. And if there’s not, I’ve never seen somebody file that objection, just frivolously.
Joe Valley 20:13
It doesn’t keep in mind, we’re spending, we’re spending conversation on stuff that happens like 1% of the time. It’s it’s very rare. It’s the exception rather than the rule that there’s any issue with the whole back being released. It’s usually just automatically released to
Mark Daoust 20:27
only bring it up because you’re right. It doesn’t happen. But it’s the fear is the fear. Yeah, yeah. All right, holdbacks, all bets are a common thing. I actually, I like holdbacks, I think that they work well, for everybody, including the sellers. I think that they are a good mechanism to have when structured properly. Guys, we have we have seller financing. We have hold backs, we have cash. What’s next? Huh? Yeah. Oh, my goodness, what’s our notes? Were a question. Yeah, I don’t know it’s work.
Joe Valley 20:59
So, you know, earnouts, typically, in my view, have always been reserved for businesses that are trending down, and they’re in trouble and somebody needs to jump on that shit and plug all the holes put out the fires that type of thing. Or the complete opposite, where the seller, the business is trying to capture upside, because the business is growing like crazy. It’s changed a little bit as businesses get our listings get larger, you know, and the aggregators and in the in the, in the FBA space, are trying to get earnouts into everything. And they seem to, they’ve done a really good job, his marketing and his profit sharing programs, which is stunning, but it’s really an earnout. And so what I what I do in the in the book is break down the different types of things that you should focus on in an earnout. And the first is, don’t ever accept it or not, if at all possible, right exceptions to every rule, as a percentage of EBITDA, or profits, or net income, or discussion, earnings, or whatever language somebody wants to put in there. Sometimes they’ll even do it as gross profit. In my view, it’s just simple math that you if somebody’s insisting on it being a percentage of gross profit, or a percentage of net income, that dollar amount that would equal can be calculated as a much smaller percentage is something that’s much more measurable, easy to measure, without any trickery. And that’s as a percentage of total revenue. My first advice is make that payment, a percentage of total revenue and nothing else. That way, it’s very easily measured with no trickery involved whatsoever. And again, just like with a seller, note, the shorter the better you you’re going to be friends with your buyer, or your buyers can be friends with you, the seller until something goes wrong, right? The further out you go, the more risk there is, and if something goes wrong, and they find a way to manipulate that net income number to reduce how much they’re paying you. And that’s why I think it’s best to tie it to the top line revenue number.
Mark Daoust 23:09
Well, I think it’s it doesn’t even have to be trickery, right? When I bought the last business I bought, which was years ago now, personally, I bought it from as running as a solo business, essentially, he was doing all of the work. I don’t have the capacity to do that. I brought on staff right away. So he was earning, let’s just say $100,000 per year, I took on that business for different reasons. When I took it over, I was not earning $100,000 per year because I was paying staff to do most of what he was doing if we hadn’t are not tied to bottom line earnings. Look, look, look what happens, right, all of a sudden, those bottom line earnings were snapped up. Alternatively, the buyer might want to try a different initiative, they might want to try a different advertising program. That doesn’t work. It’s really tricky. What you have to do if you’re going to tie to bottom line earnings, which I agree don’t unless there’s some really crazy exception is you have to define what that is. And you have to limit what that is right? We agree that EBITDA will be defined as no more advertising expense than 20% of revenue, it becomes super complex. Revenues easiest, gross profit is an understandable one, I think, a decent compromise position
Joe Valley 24:19
for only to find gross profit, because we see P & L’s that have gross profit and all sorts of things about that lies.
Mark Daoust 24:25
Absolutely, you’re right, their gross, gross. Gross Profit has a definition. Right? And it is a fairly clear definition. And that doesn’t mean people are always using it the right way. But yes, the clearly defined metrics are what makes sense. When it comes to earnouts. Though, Joe, do you go into the obviously you talk about a percentage of revenue as our percentage of sub number to go into other types of earnout scenarios such as goals and targets?
Joe Valley 24:57
Yes, absolutely. We go there’s actually five point The first one is making payment a percentage of revenue. The second one, pretty simple, make monthly payments, steady monthly payments, just like seller notes remove that doubt concerning the stress of the unknown. The third one is what you’re addressing now, which is financial caps. As a buyer, what you might want to do is, you know, present an earnout that is structured so that, you know, the percentage that they’re going to get is a percentage of total revenue up to a certain dollar amount. So x is 2%, and y is the total dollar amount, there’s a cap there, you’re not going to pay them, you know, 5% of total revenue for three years. Because if you grow the business like crazy, you’re going to pay them a lot more sellers, that’s what you want buyers, that’s not what you want, you want to do buyers, you want to do a percentage of revenue, up to, let’s say, $100,000. So they are now let’s say you’re buying a business for a million dollars, and you want to do 10% of that as an urn out. And you’re going to get 5% of revenue up to $100,000. If and this this, this balances the risk between the buyer and the seller, so that if the business grows like crazy, because the buyer has done some amazing stuff, or just continues to do what the seller did, that you do that mass so that that 100,000 is paid out in 24 months, if the growth continues that same at 5%. But if the buyer does something that it doubles in 12 months, the sellers gonna get paid out much sooner. Conversely, if the business is not all it was cracked up to be, where the seller does something, or the buyer does something that just didn’t make sense, and revenue is flat, and that instead of it growing like crazy, it flatlines or goes down a little bit, it’s a balance of risk. And that burnout is going to take longer. So you do the math on $100,000 getting paid out in 24 months, as a percentage of total revenue up to a cap. But if the business goes down, it will take maybe 36 months, or really, in a situation where it goes down a lot could be 48 months. And that, oddly benefits the seller in a certain way. And it’s because you know, again, the further out the more risk there is, in this situation, the business is a little bit of trouble, but the seller is not taking everything they could possibly take from the business at a fixed dollar amount with a seller notes, they’re taking a percentage of it. And it It leaves more cash for the current owner of the business to write that ship and fix it. The last thing on the earnout and financial cap is that are an answer are used by buyers to keep the seller involved and motivated. And so if things go astray, in that, you want to reach out to that seller, but beyond that, you know, initial 90 day period, you know, the kind of going to be there for you. Because you know, they’re still getting paid as a percentage of total revenue and they want the business to succeed. But that that that financial cap, as a percentage of total revenue up to y is something that does actually work well in both the buyer and sellers favor,
Mark Daoust 28:16
you know, with with the earnouts the one thing I’m just gonna say about this, you’re just hearing you talk about this, and I’m sure people that are listening to this, this is something that probably is more digestible, when you read it as well, absolutely. Yeah, or not, are considered them to be like the advanced ninja way of structuring a deal, right? Because they can, they can really accelerate your profits from a sale. And they can also work against you and cause you to lose out value if you don’t know what you’re doing. But the the, where we see the most value out of transactions, in my opinion, is when somebody smartly structures and earnouts. Right, when they’re able to figure out and, and, and devise a structure, which allows them to get ample cash flows. Plus a lot of upside on that. And when that business takes off afterwards, especially depending on who’s buying the business, there can be a significant amount of added value, you might sell your business for 2.83 3.2 in terms of cash, but then be able to see a four or five or in fact of you know, six plus sort of multiple on the earnout if it’s structured, right, and if you figure out the right things, and that’s where as a seller,
Joe Valley 29:25
you don’t want that financial cap, right? You don’t want to be limited to 100 or $200,000. You just want 5% of total revenue, you know, for 36 months, or 48 months or something like that. And I’m saying 5% just as a round number, it’s not not that the fourth point in the round structure is pretty simple. Keep it short, right? You know, if you’re doing a cap tried to do it over a 24 month period, again, as Mark said earlier, the further out it goes the riskier it gets so for your purposes, keep it sweet and short. Unless you’re shooting for the moon and don’t want that Financial cap, just keep it, you know, percentage total revenue for as long as you can. The last point that we dive deep into in the book is, is actually, it’s pretty simple, right? So you, you don’t want a percentage of bottom line revenue, because there’s a lot of math and trickery possible other expenses, let’s let’s take the word turkey out of it, but other expenses that could be in there that weren’t there when you were running the business. But you want to find a way to have the ability to have view only access to the data that shows the actual revenue being produced. And in the case of an Amazon business, that’s pretty clear and pretty simple. It’s the seller central account, but view only access to those types of reports will appease your stress and anxiety in the first few months, it will also help you be able to do the math, instead of just trusting the math on on the wire, though, Ah, that was deposited to your account, it should come with a report. But you should also be able to access that report and run it yourself. This is peace of mind.
Mark Daoust 31:08
I’ll run this up just with one thing. Well, that’s and I’ve taken away 14 years of doing this now, for sellers on this and that is know your buyer and get to know your buyer. And understand due diligence is a two way street, right? Especially if there’s an earnout involved, you have the possibility, you have the potential of actually getting more value from an earnout, if you have a really good partner, if you like who’s buying the business, you see that they have a lot of finances behind them, they have a lot of capability to have a good track record, that’s a company that I might hitch my wagon to a little bit and say I’ll take a little bit less cash, maybe I close for future upside? Or maybe I’m going to just try and tap into that future upside and but if if I think that the buyer is, you know, I hope they do well, I’m gonna support them, but I’m not sure if I really trust them as much. Maybe at that point you you throttle deal more towards cashier side or look at that. So your due diligence is a two way street. Right. And
Joe Valley 32:03
you know, part of what the purpose of the entire book is, and this particular chapter in itself is is trying to remove this, this quote of, you know, an increment, mine always says no, because, as you just said, there could be real financial win. If you hit your wagon on to an earnout and a seller that you have a great deal of confidence in. Now you don’t know who they are when you list your business for sale, but I promise you that you will get to know them during that interview process that lol process, due diligence process, and so on and so forth. So you’ll really get to know them. So just saying no out front, is something that I’m trying to help people stop doing and be open to listening and learning and getting an education and training. As we talked about in the book, we’re trying to instead of exit planning its training, and this is part of it, getting trained on the different types of deal structures that you may be presented with. And removing that an ignorant mind always says no,
Mark Daoust 33:02
yeah, I don’t I don’t want to belabor the point too much. But I’m gonna just bring this point home with with two examples here. Well, just one example. This silly example. Let’s assume that you put your business up for sale. You find out the buyers Elon Musk, would you take an earnout with from from him? It’s a percentage of revenues for the next three years. Yeah, right example. If the plans are Yeah, I’m gonna tweet it out to my gazillion followers on Twitter, right, the guy’s own flame throwers. And made a bunch of money. Yes, of course you would write if it’s a celebrity. And this happens if it’s a celebrity buying your brand, and you know that they’re now going to use their influence. Yeah, I want to tap into that. So anyways,
Joe Valley 33:47
we move on to the next. So we go and cash seller notes, holdbacks, earnouts. Last one, actually not the last one. The next one is something that if you Google it, you won’t find it because it’s creation by these FBA aggregators. It’s called stability payments. And it’s an interesting one, because it’s really just a combination of a seller notes and earnout. But they’ve given it a new name, because they’re amazing at marketing so much better than we are rapidly calling these things that really just an earn out, or it’s just a stability payment. But the concept is pretty simple. It works like this. If if the revenues, this is the way they frame it in a letter of intent, if the revenues of the business are within, let’s say 90% of the trailing 12 months at closing, you the seller will be paid a stability payment of x. And e x is usually about 10% of the purchase price of your business, but it can definitely vary. So let’s just say that your stability payment, let’s go with the $200,000. So you’re selling the business for 10 million, your stability payment is 10%. So you’re not going to get that 10% that 10% is not going to be held in escrow and you’re only going to get that 10% if the revenue of the business is with Then 90%, of where it was, when they bought it 12 months after they bought it, it’s interesting, the problem with the initial language that they will throw at you is that it’s 90% or nothing, right? If it’s if it’s at 89.99%, you will not get paid that $200,000. So there’s a number of things that I talked about in the book, and it goes deep in this one, because there’s different things that you can do. But a simple one is, it’s it shouldn’t be 90%, or nothing, if it’s, if it’s if it’s 90%, you get your 200,000. If it’s 85 to 90%, you get 150. If it’s 80 to 85, you get 100. And then conversely, on the other side, if it’s 90 to 95%, maybe you’re going to get 250, if it’s 95 to 100%, right, because it is a blend of a seller note and earnout with a new name on it, but you can’t find if you Google it, you know, you’ve tried to tap into some upside as to it as well. And then that, that that clear line of 90% is something you definitely want to avoid. So you’re you’re down and you’re up, you can you can protect yourself on the downside, protect yourself from the upside. And then there’s other things that you definitely want to have in cluded in any of this. And one of them with a stability payment in particular is tied to if you’re a physical product company, an FBA seller, and you’re bought by an aggregator have it your inventory on hand tied to the stability payment, so that if they run out of inventory on your top selling skew for more than one week, at a time or two weeks at a time, you know, other than natural disasters, that all bets are off, you’re getting your full stability payment within, you know, three weeks or something like that. Just because they are well financed them well recognized in this world doesn’t mean that they’re not going to take their eye off the ball and run out of inventory. Right, they’re growing like crazy, they’re taking on all sorts of brands that are hiring new people that are not as passionate about your brand as you are. And that increases the risk of doing something like running out of inventory. And I’ve seen it happen. I’ve seen it happen where that we’re three weeks away from a $300,000 payment, and they ran out of inventory we read, you know, whatever percent, we were really close, and then they ran it inventory. Fortunately, there was a second clause in there that allowed it to roll over to the next quarter. And then my client got paid the $300,000. But we didn’t at that time have that clause in there were all bets are off. If you run out of inventory, I think I forget exactly what I wrote the book, I’ve read it 20 times. But I still when I read it now it’s like, oh, it’s new. That’s a good idea. I think I talked about maybe a two week period. But I think it’s a critical part to have in there. When it comes to stability payments, you could probably work that into different types of seller notes in or out as well,
Mark Daoust 38:07
when it comes to earnouts and stability payments and this area and even just the structure of the deal, you’re really limited only by your creativity. And so you don’t keep an open mind, obviously a stability payment job, which I thought was it’s actually my favorite format of a stability payment. The way it worked is we calculated the multiple at the close for the business. And let’s just say that was 3.7, the multiple for at the close of the business 20% of the purchase price was in a seller note, right, so there was a guaranteed amount of a seller note that was out there. However, the stability portion of this was the businesses going to grow at the rate of 5%. year over year, if it doesn’t grow at the rate of 5%. year over year, we’re going to recalculate the trailing 12 months. And, and the the the actual multiple on this. And we’ll readjust that seller note accordingly. Right, so that seller note might go down a little bit. So it might go down from 200,000 to 185,000. Right. And then conversely, if it goes up, if it grows by a certain amount, we’re going to recalculate what that seller note was. So in other words, what it did is it was like a volume knob on that seller note that would either increase or decrease but there were still these guaranteed monthly payments. It was pegged to something that was very hard and firm. We were going to get paid that was the the real key there. There was going to be payment, how much it was open to some interpretation and the performance of the business. But it was a really cool mechanism. To that I ended up I looked at I’m like this is this is creative. I like this. This is a good system and it’s worked out very, very well for that seller. That was creative. That’s why I just say when people ask me, we go over this like How to Pronounce work, how disability payments work, and I was like, it really depends. I mean, you can get creative with it. So kudos to you on trying to break us apart because it’s a big topic.
Joe Valley 40:00
It really is, it’s just that we have an affliction, right? We all entrepreneurs, anybody listening to this podcast is an entrepreneur or an entrepreneur making we have an affliction. And that is called I can do this, I could do that we think we can do everything. And the problem is that we can’t. And when it comes to what you and I do, we’ve learned through, you know, over a decade’s worth of doing it that no two deals are alike. They’re all complex in putting your biggest asset online and selling it yourself by thinking, I can do that. There’s a really, really high percentage that you’re not getting enough value for the business, doing a terrible deal structure and just putting yourself at risk your biggest asset or risk. So rather than saying, Hey, everybody, you have to work with us. I said, Hey, everybody, here’s everything that we know, it’s in this book study at Learn to train, and then you’re going to have a bluebell, you’re not a black belt yet, but you’ve got your blue belt here, you know, just enough to be dangerous, you still going to get your ass kicked by somebody with a black belt or a brown belt. But, you know, I think there’s enough education in there, that they’ll still make the decision that just based on what your what you just said, it makes a whole lot of sense to work with somebody that is an expert. And, you know, we earn our fee, very, very much 10 times over in most cases.
Mark Daoust 41:26
Alright, so really the payments moving on? Yeah, we’re
Joe Valley 41:30
moving on rolling equity. Rolling equity, is, you know, something that it means a buyer purchases the majority of the business for cash, and you the seller, roll the remaining percentage into a new co or new company that’s set up by the buyer. So if you’ve got a business, you’re selling for $100 million, and you want to roll 20% equity, there’s a new entity that’s up, you’re getting $800,000 in cash for the business, but you’re 20% is going to the ownership of that new entity that now operates the business. So the benefit to the seller is that you’re getting a pap partial cash out, you relieve yourself of that daily grind. And you participate participate in the in the upside and eventual second exit, you’ve got to trust your buyer. Of course, the benefits to the buyer is that there’s less cash needed at closing, you’re saving yourself $200,000 your seller is invested in your success and may stay on as a strategic advisor. A lot of the folks we work with are selling because they’re just exhausted from the daily grind. They love certain aspects of the business, maybe launching new skews, or podcasting or whatever it might be. But the daily grind is what they’re, they’re tired of with their they’ve limit, they’ve reached their limit of expertise, and they need to sell. So they can say on a strategic advisor. This is something that I’ve seen people, much like an urn out where they don’t have a cat and they make more money on the internet than they do on the sale of a business. This one’s rolling the dice a bit, you’ve got to work with somebody that’s going to grow the business and have a real strong second exit down the road. But it’s a good opportunity to get a second exit that could be larger than the first.
Mark Daoust 43:20
And where I’ve seen this use most often would be deals that start sniffing the lower middle market, right? So the 1015 $20 million transactions, the expectation among private equity family offices, or you know, investors at that level would be some equity rolled. They know and they really depend on that owner coming over bringing over all the institutional knowledge that that seller has built over the years so that they don’t lose that in the transition, the reward can be significant. For for the person selling, it can be a really, really good situation to have that equity roll because as you said, Joe, it’s the second exit, sometimes that second exit is significantly larger, and that even with 20% equity, or 10% equity rolled over, that can represent more money than what you originally sold the business for. What you want to look for with that would be the health of the fund that is buying your company. Also, where are you at in their acquisition cycle? So are you are you the platform investment? Are you an add on? Are they ready to exit you know, pretty soon because remember private equity that they don’t want to buy and hold necessarily they’re looking to buy, grow and sell. That is the private equity model, which again, can be really good. I’ve known people that have gone through those second exits, and they are often bigger than the original exit. So it can definitely be a huge win. I can also be something that that is difficult because you’re now working with private equity after the fact. And so once again, know your buyer, due diligence is a two way street and take advantage of that make sure that you know who’s buying the company. I know of one client who had an offer from a private equity and after Getting the private equity backed out of the transaction, because you didn’t like the finances, of the financials of the private equity, that they were carrying too much debt and didn’t feel confident in their ability to execute, that’s a fair reason to pack out, given the structure of the deal, made a lot of sense. And so I just
Joe Valley 45:19
throw in the, in case, you’re, you’re out there listening, going, Oh, so I can get cash, and then I’m going another company, and then I can’t do anything else. Now you can do anything else, as long as you use doesn’t have a non compete clause in your asset purchase agreement. So you’re not going to be able to go out and sell products in the same category or services in the same category that are going to compete for the same customer. But you can go out and start your new business, doing something that you’re more passionate about with, you know, less bootstrapping, and more, more, more cash on hand to do it, you can have more financial peace of mind. So you can still go out and go on your next adventure. While this one is, you know, greatly reduced, and you’re just having a maybe a strategic call and record or maybe you’re on a board of advisors, or something like that. Pretty simple. And you can still go out on your next next adventure.
Mark Daoust 46:08
This is not everything about about structuring a deal. No, we don’t, there’s more.
Joe Valley 46:15
There’s two more components to it, I’ll tell you what they are, it’s working capital tags and inventory notes. And they’re not, they’re not all that complex. Except that, you know, a working capital peg is more often called, it’s just called a peg. And what it is, is it’s a benchmark, a target a baseline amount of networking capital, that’s agreed upon by buyer and seller, that is usually determined to at the end of financial due diligence, I have a massive problem with that. Buyers, you know, generally are looking for a working capital peg of one to three months of working capital, so that their logic is well, I’m not going to pay a million dollars for your business, and then have to put another $300,000 in it just to cover the first three months. It’s a lot of money. You know, I think not having it clearly defined in a letter of intent gives your buyer a strong position to negotiate for more and more in due diligence. So if you’re going to have any kind of working capital peg presented to you in an offer, you got to have it clearly defined dollar amounts. Otherwise, there’s going to be a position for renegotiation and due diligence, and we don’t see that we don’t see working capital pegs, that then language in asset protection agreements, or letters of intent very often, what we are seeing, and this is the third time I’ve mentioned FBA role to apologize, because this is not this book is not just for fiscal product ecommerce business owner selling on Amazon is for everybody. But for what we’re seeing on the FBA side is the aggregators are instead of calling it a peg, what they’re doing is just asking for, you know, two to three months worth of inventory free with the purchase of the business. So, you know, they made pitch you these guys are great, by the way, and I talked about them. And I think it’s chapter 13, we talked about these guys and who they are, and they’re actually very likable, and I’d had dinner in a beer with most of them. But they’re going to pitch you on, you know, saving on the broker fee. But what they will tell you is they go to cash free business close in 30 days, takes longer 30 days, and they’re not actually going to pay you in cash, they’re going to do a combination of all these things. And generally, they’re looking for two to three months worth of inventory value, at no cost. And that’s their working capital peg, they come from the larger private equity world, or at least that’s where their money comes from. And they always have working capital pegs in there. So to make it comprehensible for the small business owner, they just say we need two to three months worth of inventory. They don’t call it a working capital paper. That’s exactly what it is. That makes sense.
Mark Daoust 49:03
The reason behind it just to go over this not not saying it’s the right way to approach this because I also have a fundamental disagreement with them. But the reasoning behind it is a much more mature business has a certain amount of cash that is typically not touched in a business. There we go, my camera just went off, we’ve been talking too long, Joe, my camera went off. I was even looking at anyway. So for those on the YouTube channel, anyway, so there’s a certain amount of cash that a more mature business typically doesn’t touch within their business, right? The, you know, it might be $100,000, if they just keep because they know that they’re going to be carrying certain expenses, they’re going to be needing that money in order to continue to run the business because it’s not touched. It becomes a core asset of the business, which is something that is expected to be transferred over. The reality of the negotiation is it often becomes a negotiation piece in which they the buying company can reduce the amount of cash that they’re paying for your business. And maybe they take a little bit more out of that working capital peg that they They’ve put in place. This is always an argument I have for hiring the good CFO, fractional CFO for your company, especially as you break a million dollars in revenue or more to help identify what is our working capital? Because that’s really what the argument is around, what is the working capital in this business? What are the working capital requirements, and you can set that off from the beginning and have a calculation that supports that, Joe, you say all the time, and you’re absolutely right. It’s math and logic, so beat them to the math and logic game. By having the math and logic out there. If if you have a larger transaction, if you have a transaction 10 million or or above, expect there to be a working capital peg, and be the one to define it be the one who say the working capital for my business on a three month basis is $150,000. Right? And then we can build that into the actual price of the business, we can build that into the asking price, you’re not finding somebody else coming to you with the calculation saying your working capital is $725,000, we’re gonna take that off of the purchase price, because we need that in order to run the business. And you’ve that’s what you’ve been using for your business, that these things can be calculated, they can be debated, they can be determined.
Joe Valley 51:08
Yeah, it could be deep and confusing. I try to simplify it in the book as much as possible. And we’re getting into some pretty deep stuff here, folks. But you know, the way that the book is written is if you’re just having a beer with me across the table, I might be drinking a non alcoholic beer, because that’s my approach these days. But it’s still very conversational. Somebody that read it recently told me it’s the it’s the clearest and most easy to read, m&a book he’s ever read, and this particular person has read lots of them, because he’s in that world. The last thing that is after working capital pegs ties into, you know, you know, a bit of a way to get around paying for working capital pegs, and its inventory knows, instead of giving them two or three months worth of inventory, or with any with any purchase, if you want to help your buyer, which is what you should be doing right, this has to be a win win. If you want to help your buyer buy the business with, you know, without putting all of their cash on the table, the easiest possible thing for you to do is an inventory seller. Note, it’s an inventory of note, it’s not a big seller note that’s 12 to 36 months, this one’s just tied directly to inventory. And it’s a real easy win win, it’s got to be short, three to 12 months Max, and it’s specifically on the inventory, think about it, odds are you probably have three to four months of inventory on hand, if you give them a four month inventory note that might be $200,000 that they don’t need to come up with that closing. Remember, they’re paying your business that in multiple of excuse me in discretionary earnings, plus the landed Cost of Goods sellable inventory on hand at the time of closing, but you can calculate that amount and then do an inventory seller note so they’re not having to pay that at closing. And you’re getting monthly payments on it that are very short. Again, back to what Mark said the longer that note is, the riskier it is keep this one short, I often like just focus on how often does your inventory turn. And that should be the length of the seller note and it absolutely should be you seller, it’s you should get the landed Cost of Goods sellable inventory on $1 for dollar value, assuming it is good, sellable. That’s the key thing in there and landed, you paid to put it on a boat you went through importing it to customs in the US and then shipped it to your third party fulfillment center or to an Amazon fulfillment center. And that all costs money that should be calculated into your cost of goods sold. It’s not just the purchase price, your you know your your $2 on the product or $20 in the product. It’s what it costs to get it to the fulfillment center as well. And again, it’s paid out in addition to the purchase price. The exception is sometimes those FBA roll up companies look for that two to three months worth of inventory. And that landed cost is the key differentiator. But that’s it Mark we’ve covered all of them in the deal structures. The next chapter after deal structures is actually negotiating with them and how to negotiate on these different types of deal structures. So we went over variations of cash offers cash plus all of these different things that can be involved with it, which is seller notes, holdbacks, burnouts, stability payments, rolling equity and working capital and pegs. It is deep. It’s involved, but it’s me speaking and it’s my words in my language. And y’all know I’m not that smart. So it’s pretty easy to read and understand.
Mark Daoust 54:39
And he doesn’t have me coming in and confusing the topics with additional what I think to be insights now this is really good. Again, like I said, this is a complex topic or can be a complex topic to try and break apart but trying to, you’ve done a good job making this simple, understandable, and then advantage and I just wanted to kind of maybe round it out with this Why learn all this stuff? So many people come to me and say, I’m not taking an art up? I’m not doing installer. No, I’m not doing I’m gonna do cash, what you’re effectively doing is you’re reducing your buyer marketplace, when you do that significantly reducing the buyer marketplace reduces your pricing leverage, which closes you out to potentially good transactions. You don’t have to take any of these deals, but knowing how they work and knowing how to evaluate whether or not it’s a good deal is really a major aspect of this. So being able to understand this and sit down and read it, and I’m sure when when people read this, they’re gonna see all this, this makes sense. This is this isn’t that complex, this is actually pretty understandable. It was just going to be a huge help for anyone going into this process so that you’re not trying to evaluate an offer. When you’re looking at these mechanisms for the first time. That’s difficult. So being familiar with it is awesome. So congratulations, hats off to you vote for putting that together. Yeah,
Joe Valley 55:55
thanks. Again, we’re gonna give away three free chapters of the book. There’ll be in the show notes, you should be able to get them from from the website and the podcast page. Actually, it’s four things I’m giving away the the total intro to the book. So everything that’s written there, we’ve got some nice endorsements. Gino Wickman is on the cover of the book saying this is a must read for online entrepreneurs Sam Parr from the hustle and trends was kind enough to write the foreword. And then we give a detail on what all of the chapters are and go through the entire intro of the book that’s given away. And then we’re giving away three that I think are key chapters that sellers and buyers can both benefit from one is a valuation overview how it works, what buyers looking for, what they fear, what sellers need. And then chapter 11, which is identifying all of your add backs. And then chapter 15, just what we talked about today, structuring the deal.
Mark Daoust 56:56
Fantastic, guys, thank you so much. This was a longer episode. Today, we wanted to delve into a chapter and give you all that free content here in the podcast. If you enjoyed this podcast, take a moment go over to iTunes, go over to Spotify, wherever you’re listening to us and leave a rating that would be very, very awesome. If you’re able to do that. please do leave a rating leave a comment if you got anything out of this episode, something that you learned. Take a look at the show notes. You can find it on our website and get your free three chapters and the intro as well. To be able to get a sneak peek at this book. You’re going to like it it’s the only book of its kind on the market. Or at least it will be once it comes out. It’s the only book that’s been written like this. So super exciting. Joe that was a lot but that was good.
Today’s podcast was produced by Rise25 and the Quiet Light content team. If you have a suggestion for a future podcast subject or guest Email us at [email protected]. Be sure to follow us on YouTube, Facebook, LinkedIn, Twitter and Instagram and subscribe to the show wherever you get your podcasts. Thanks for listening. We’ll see you next week