Over the past few months, we have provided insights into how to prepare for the sale of your business. This month’s article focuses on options for payment upon closing of the sale.
Vendor Financing
Vendors can sometimes increase the likelihood and speed of a sale and improve their return by offering to finance the purchase price, meaning that the vendor is paid over time. Offering vendor financing demonstrates the vendor’s confidence in the success of the business, since the vendor will have an ongoing interest in the profitability of the business.
With vendor financing, the vendor is usually granted some form of security by the purchaser. The vendor needs to assess whether the purchaser should grant personal guarantees, mortgages on real property, general security agreements and other forms of security. The extent of security required by the vendor depends on a number of factors, including but not limited to:
- Whether the vendor will continue to be actively involved in the business;
- The amount of money owing by the purchaser; and
- The extent of other financing used by the purchaser to pay the purchase price.
It is also possible to hold assets or shares of a business in escrow until such time as the purchaser has paid the full purchase price, with the assets or shares being returned to the vendor if the purchaser defaults. However, vendors may not view the return of the business as an acceptable outcome.
Earn-Out Provisions
Business sale agreements sometimes contain “earn-out” provisions, where the purchase price is adjusted depending on the future performance of the business. Common provisions include earn-outs based on revenue or earnings, or earn-outs based on company milestones such as winning a particular contract.
Although earn-out provisions are an adjustment to the purchase price, the vendor is not paid the full purchase price until after closing and should therefore treat the provision as a form of vendor financing. The vendor needs to ensure that the adjustments to the purchase price are clearly defined and that the vendor has some opportunity to monitor whether milestones were in fact met. For example, a vendor may want to retain the right to request an audit.
Both vendor financing and earn-out provisions significantly increase the risk borne by the vendor and must be carefully drafted. Please consult your lawyer prior to agreeing to such provisions.
Such provisions may also have tax consequences for the vendor, which you should discuss with your lawyer or accountant.
How Pushor Mitchell Can Help
For over 35 years we have been assisting businesses of all sizes achieve their objectives. We do so by gaining a deep understanding of our client’s business and then working hard to help clients succeed. Our clients include emerging businesses and well established corporations across most sectors of the economy. For more information on our Business Law Team, please visit http://pushormitchell.com/service/business-law.
