Come Together
Want to buy a successful business—and keep it going strong? An earn-out agreement puts you and the former owner in the same corner.
Question: I just found out the owner of a local Italian restaurant is planning to retire, and I’m thinking of approaching him about buying his business. But I don’t have a lot of cash to put down, and I’m not sure if I can qualify for a bank loan. I’m also worried that, once the owner leaves, a lot of his customers may go elsewhere. Any ideas?
Answer: One option to consider is an earn-out. Unlike the billion-dollar mergers and acquisitions you read about in the newspaper, buying a small company can be tricky--for both the buyer and the seller. Without a public market to set the price, calculating how much a small, privately held business is really worth is not always easy. And if the owner is a popular figure in the community, the customers who were loyal to him may not be loyal to you. Structuring the deal as an earn-out can solve these problems.
With an earn-out, the buyer typically puts down a small part of the purchase price in cash--say, 10 percent--then pays the seller the remainder over a period of time as a multiple of the company’s revenue, earnings or other financial metrics. The advantage for the buyer is that he doesn’t risk overpaying for the business if the company can’t sustain its current level of sales or profits. The good news for the seller is, if he believes his company is undervalued, he can often get more than the buyer was originally prepared to pay by working with the new owner. That’s why buyers should be sure to give the seller an incentive to stay and teach them the business, and tie their compensation, at least in part, to the company’s financial results, says Joseph Goldberg, a partner at Hodgson Russ in New York City, who works with closely held businesses.
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Rosalind Resnick is the founder and CEO of Axxess Business Consulting, a New York City consulting firm that advises startups and small businesses.