Are you buying or selling a business and unsure of how to structure payments?
There are hundreds of different ways you can do this, and what you choose really boils down to your own personal preferences, business needs, and industry markers.
Structure Payments the Way You Want
Ultimately the way that you set up your deal stack is your choice. It will depend on a number of things, including:
- Your industry
- Financing options available to the buyer
- Why a business is closing
- Whether you set the asking price
- Your overall comfort zone and preferences
- Your debt, equity, and asset ratio
- Your business management approach and style
Your deal structure also depends on timing. Obviously, the current global pandemic has had an extreme influence on the economy, and this will affect the way your business is valued.
How to Determine the Value of a Business
What’s a reasonable price for a given business?
There’s no single formula that can pinpoint an exact value of a business.
If you are the seller, you need to gain clarity on your terms so that you can structure your deal, and if you’re a buyer trying to understand an asking price, you need to know that the business will likely be sold based on the seller’s terms.
All parties involved in the transfer of ownership need to agree with the valuation assessment in order for the deal to move forward, and negotiations are standard.
Here are two standard calculations that are often used to help determine a price, which can then be used to determine how to structure payments.
Seller’s Discretionary Earnings (SDE)
This method is relatively informal and generally used for small businesses and is made with the assumption that there is one full-time manager accounting for labor costs.
The SDE is a calculation of expenses which will account for the total owners’ benefit, such as:
- Amortization of non-cash items
The total is then used in reference to an industry standard.
Earnings Before Interest, Depreciation Taxes, and Amortization (EBITDA)
This calculation is generally used for businesses that make over $1,000,000 annually.
One of the reasons people are wary about using a single calculation to determine something that is quite complex and even variable is that it is sometimes used to estimate cash flow.
Whether you are buying or selling, do bear in mind that the number generated from this calculation is entirely separate from cash flow, and does not include important factors such as interest or depreciation.
This total also is compared to an industry-standard but should not be taken at face value.
Your business advisor, accountant, and/or investment advisor can help you determine an appropriate valuation of your business.
Negotiating Payment Structure & Terms
Once the seller identifies an appropriate value of the business, they can set an asking price and build out a reasonable plan to structure payments.
Successful transfers are usually made up of deal stacks or structures which are created during negotiations between buyer and sellers.
This will depend on considerations such as:
- Taxation structures
- Interest payments
- Stock purchases
- Stockholder preferences
- Debt, equity and assets
- Business size and ownership
If you are purchasing a business, you’ll likely be at the mercy of the seller, more or less, with regards to payment structure.
Debt may not be as much of a problem as you initially think, though; depending on your industry, you may even be able to use it to your advantage.
Here are some tips on how to finance your business in difficult times.
Types of Transactions
Here are just a few examples of the different payment structures a business transaction may take on.
Installments are very common for both smaller businesses and larger corporations, where the seller will receive a larger amount in total.
The advantage to the purchaser is that they will have the opportunity to pay the seller back over time.
To determine a deal structure based on installments, a seller should account for capital gains, taxes, and other factors as they may accrue in the future.
Earnouts are a way to structure payments so that there is a set of milestones after the deal is closed. This is of benefit because it means that the tax burden can be spread out over time.
Assets and Equity
You may also choose to structure payments so that they are based on a combination of stocks and cash.
Typically selling stocks is a simple option with less of a tax burden for sellers, but riskier for buyers.
Purchasing assets is a good choice for buyers as it will offer more of a clean slate for the purchaser to build their own business, but it can be a disadvantage to the seller in comparison to other options.
Get Help Structuring Your Business Deal
Running a business can be difficult enough when the economy is strong, but in times of uncertainty, taking risks can cost you too much down the line.
Our business attorneys offer consultations, risk assessments, and other business services to ensure your assets are protected.
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