Difficult Transactions
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March 1, 2012
Volume 3, Issue 3, March 2012
Page(s):
After working diligently to build a valuable asset with your laboratory, you have reached the point where you feel the timing is right to sell the business. A potential buyer has been found, and you start negotiating a price for the sale. Attorneys and accountants are involved, and you and the potential buyer are close to an agreement but there still remains a difference in the price. The buyer seems like a reasonable person so you do not want him or her to walk away from the transaction when a little more creativity may be able to allow it to take place. What more can you do to get to the closing table? You do not want to accept the amount that the buyer offered, but you want to prove to the buyer that you are correct in your analysis of the value of your business and that it will produce the cash flow the buyer needs to pay off the acquisition loan. The buyer does not want to accept the offer that you want for fear of a lesser cash flow, even though the future projections look good. These forecasts are not guaranteed, and the buyer does not want to default on the loan because of overpaying the sale price.
When there is a stalemate, a concept known as an “earn-out,” agreement may be a solution for the buyer and the seller in closing the purchase price gap. The way an earn-out contract works is that an agreed upon price is determined and accepted by the buyer and the seller. That amount is paid to the seller at the closing of the transaction. In addition to this price, the seller commits to the business while meeting certain financial goals over a period of time to earn the “dollar difference” in the selling price. An example would be a sales price of $250,000 that is paid today. The seller wanted $300,000 but could not convince the buyer that the laboratory was producing enough to warrant the extra $50,000 payment. The seller and buyer agree that if certain conditions are met such as sales volume, increased profit margins, or some other definable goal, the buyer then must pay the additional $50,000 to the seller. If the laboratory generates the additional $50,000 payment to the seller, it meant that the buyer was able to earn well in excess of the $50,000 or the agreement would not have been consummated.
Both the buyer and the seller will surely have accountants, attorneys, and other expert advisors assisting in the negotiations for the sale. Earn-outs are not commonly used but are very effective when reasonable people are negotiating and are sincere in their efforts for completion. Some advisors do not see both sides of a picture and only want the most for their client without concern for the other party. These types of advisors will not allow this type of transaction to take place, and the seller can say good-bye to the potential of having the big pay off of a long journey’s efforts. There are risks that the buyer may not be able to achieve the threshold of gross revenue—as an example—to be able to attain the amount needed for the earn-out to be reached. Even if this should happen, using the above $250,000 transaction as a guide, the seller still would have received the buyer’s dollar amount at the settlement table. This is important when considering whether there are any other potential buyers out there who would pay more than $250,000, and also how long it would take to get to the closing table. The potential for the additional $50,000 that would come from what was produced by the buyer in a given timeframe of the next 12 months’ gross revenues, for example, produces additional revenue for the seller and the buyer as well. It is rare to find a situation where both the buyer and the seller feel as if they have both achieved the best deal possible. If the buyer can pay the additional sum, the buyer now has a laboratory and has a higher-producing business than what was thought in the decision process.
Good business advisors are difficult to find. A good starting point is to contact your CPA to see if he or she is experienced in advising on the ramifications of earn-outs. The CPA may have a good contact with attorneys who have sound business experience and who want their client to succeed and not wait for the highest price that may never be achieved. If your CPA or attorney does not have the experience with this type of transaction, your supply representative may have some knowledge from speaking to other laboratory owner customers who have sold their businesses. Sometimes the contact with others in similar situations will lead to the discovery of someone who has the knowledge and experience to be able to complete a transaction where the buyer and the seller each get what they want.
Bruce Bryen, CPA, is a managing partner of Bryen & Bryen LLP, Certified Public Accountants, in Marlton, New Jersey. For more information, please contact Bruce at 800-988-5674 ext. 112.
