You May Not Get as Much Cash as You Expect When Selling Your Business

Founders are often surprised to learn that most buyouts won't result in them receiving 100% of their proceeds at the close of escrow when selling their business. Deal terms and structure make a massive difference - be careful!

Video Transcription

Good morning. I'm Kirk Michie, the candor advisors. On our weekly update this week, we wanted to dig in a little bit to a common misconception founders run into when they're selling their business. And that is that you are not, regardless of valuation, going to end up with a big wire transfer into your account for 100% of your equity. 

In rare cases, that happens if you sell your company to a big competitor, who might give you what's called “100% cash at close”, and just need you to stay around to make sure they know where the keys are, hand over the computer logins codes, and ride off into the sunset.

But for most founders, that's not what's going to happen, especially not if you sell to a private equity firm, which by the way might be the best path to exiting your company.

It just kind of depends. That's where we specialize, so let me kind of give you a quick walkthrough on what's more common or more normal. 

If you're a founder and you sell most of your company, in what's called a majority recap transaction, the financial buyer or private equity firm is going to give you more than 51%, let's say 60, 70, 80% of the value of your business in cash at close, and then likely, they're going to ask you to roll equity. And what that means is they're going to ask you to retain an ownership stake - common equity in the business after they bought it so that you can play for what's called a second bite of the apple, when down the road they sell your company again, you collect more money on the rolled equity. 

That'd be common, simple structure, but there were other things that might happen too. They might ask you to take back a note, kind of like somebody might ask you to take back a note on your house when they're selling it, and if they're going to pay you an above market interest rate to take back on a note on your business, that might be a great option for you. You'll continue to get the income from the business. Likely, they're probably going to issue what's called a pay in time security, which means the interest payments on the debt accumulate over time and aren’t paid in cash. That can be great from a tax planning standpoint, but it can also be lousy if that degree of leverage puts the business in jeopardy and reduces the likelihood that you'll end up getting paid back.

They might also ask you to do what's called an earn-out. That might be a great if the business is growing, and you get to participate in those future profits on the business if things go as planned, but it also might mean that you don't get full value for your business, if something happens down the road that reduces performance and your “earn out” accordingly.

The key here is to make sure that when you're selling to a financial buyer, who's not going to give you a hundred percent cash, maybe do a little bit of parallel due diligence on their track record and ask for references. Have they kept their promises to the companies they bought out? Find out if you can talk to the other founders who sold to them. And do they have a published record of their results? Look, they're an investment firms, so they have limited partners or investors in their prior funds or investments. You should be able to ask how they've done on their prior investments, because if you roll equity, you're in effect becoming an investor in them and their portfolio. So, you want to know all of that before you sell, and then structure might be a wonderful thing.