Here’s what really was going on with this “deal”:

The P/E firm was uncomfortable with the lack of diversification in the customer base, and the company was not taking advantage of its reputation in ancillary products and markets. Jim, also, was the core of the business. He managed the pricing, shipping, and supply chains.

While he had managers in the field, the large, national (at least East Coast base) accounts were built on his strong relationships. There really was no strong “team”. Jim, a couple of field managers in 3 cities, and his accounting and Admin staff in the home office were the backbone of the business.

Most deliveries were outsourced, and that was probably something Jim should have expanded before thinking of selling. At any rate, the P/E firm thought this was a “good” business, but they were not going to go all in. With a Multiple of 4, they felt they could buy the business for $8 million.

Paying out another $4 million over 3 years, essentially after expanding into new markets, investing additional capital in technology and better customer order/service would allow them to pay out the deferral out of pretax earnings. And for insurance, they wanted consideration to the EBITDA calculations, (which would be the benchmark for the deferrals) to include a new manager they already intended to hire to manage the “investment”.

With Jim tied to performance, they felt the new manager could transition the business for the

new owners with little risk. And that “risk” would still be “owned” by Jim, not the P/E firm. Exactly as they wanted it.

This deal was, in actuality, a 4x Multiple, made to look like a 6x if everything went well. But if it didn’t, the P/E firm felt $8 million at a 4x would be a safe price to pay. Jim would be the one shouldering the premium risk.

And being paid that risk money out of future earnings… A good deal for the P/E firm…

Many a deal is tied to the owner's continued service. Sometimes, it is a plus for the transitioning owner. More often it is a case where the buyer simply will not assume all the risk. They will pay 50 or 60% of the business, tie the balance to some not unrealistic benchmark, but then only payout that deferral out of the earnings, not out of their pocket.

That is money you worked to generate but did not share in as an owner. You shared in it

as an employee or consultant. Not the same.

In Jim’s case, he was offered a 4x Multiple. The buyers simply were not willing to pay the fair market 6x multiple, feeling there was too much risk tied to the transition. Thus, they structured a complex deal where they were willing to pay 4x, keep a large share of the back-end risk on Jim, and then pay him out of this own company’s earnings, should in fact things go as planned…

Which, as events would have it, they did not, due to Covid. Had Jim sold in 2018-19, he would have ended up with the $8 million, and like as not, nothing else as the EBITDA benchmarks was not met and thus the deferral would have been forfeit. By the time the business rebounded, Jim would have been out of his upside opportunity, and the company would recover without his having any additional participation.

The moral of the story: unexpected things happen. If you sell, get what you hope for upfront. Deferrals are often used by buyers where they are unwilling to shoulder 100% of the risk at closing. You either take back paper tied to performance or simply have a structured “payment schedule” that is at risk to performance benchmarks. All of this is simply because the buyer perceived risk where you didn't.

They wanted you tied into the back end, the riskier end of the transaction. Earnouts are common in smaller transactions but limit the contingencies. Understand that deferrals exist because the buyers do not want the additional risk they perceive in your transition. Not only does it mean they have less money at risk, but the future payout to you came out of future earnings of your business you no longer participated in!

A double blow to making the deal “fair” if the risk were not an issue. The best way to sell is to reduce that risk in the first place, get your money upfront, and if they wish you to stick around as a consultant to the transition, fine. But do not have the success of the deal contingent upon future expectations where you no longer have a say in the business, let alone the

profits.

That simply is not a deal you want to be stuck with if you can avoid it.

The message of this story is: Get your business prepared before you go to market!