The first thing every owner asks is the price, and it is the wrong first question. The money you keep is decided by how the deal is structured: how much of that headline number reaches you, when, and what you have to do to earn it. I have seen owners take a lower headline with better structure and walk away richer and happier than owners who chased the big number into a trap. You can win on price and lose on structure, so read the structure first.
Break the headline into pieces
When a buyer names a number, break it into pieces before you let yourself feel anything. The common pieces are cash at closing, the only money you are truly certain of; a seller note, where you in effect lend part of the price back and get paid over time with interest; an escrow or holdback, a slice parked with a third party for a year or two to cover anything that goes wrong against your promises; an earn-out, where part of the price is paid only if the business hits targets after the sale; and rollover equity, where you keep a piece of the new combined business. As a rough anchor, the cash you take home on closing day in a typical lower-middle-market deal lands around 70 to 90 percent of the headline, with the rest in those deferred pieces. Make sure the cash at closing, by itself, is a number you could happily retire on, and treat everything else as a promise of varying quality.
The earn-out trap, in plain English
An earn-out sounds fair when the buyer describes it. We both believe in the business, so let us tie part of the price to its results. Here is the problem. The day after closing, you no longer run the business, the buyer does, and the buyer decides how much to spend, what to invest, and how to count the numbers your earn-out depends on. I am not telling you to refuse every earn-out, because sometimes it is the only way to bridge a gap. I am telling you to protect yourself. Tie it to simple, objective measures like revenue rather than net profit, which the buyer can move around. Define every term in writing. Get a written commitment that the buyer will keep enough marketing, staff, and investment for the business to have a fair shot. Keep the period short and get audit rights. And above all, treat it as a bonus on top, never as the deal itself. If the earn-out pays, wonderful, and if it does not, you should still be fine.
The tax basics that quietly move your take-home
I am not your tax advisor and this is not tax advice, but I have to wave a flag here, because the structure of the deal can change your tax bill enormously, and on a large sale the gap between a well-structured deal and a sloppy one can run to seven figures. A few ideas are worth carrying into the conversation, at the idea level only.
I learned this long before Protect A Bed. When Toys R Us came after my South African stores in the early nineties, we turned the lawsuit into a deal, structured with help from Arthur Andersen. I sold them the Toys R Us South Africa trademark for ten million dollars, and I bought the franchise rights back from them for the same ten million. The cash netted out to zero, but the form of the deal mattered enormously. Selling the trademark outright meant a big tax advantage. Had we taken the same money as license fees or a legal settlement, the taxman would have kept roughly four and a half million of it. Same handshake, same money, four and a half million dollars apart. That is what structure means, and it is why the right advisor earns their fee many times over.
- Asset sale versus stock sale. The buyer almost always wants to buy your assets, because they can write off the purchase over time. You usually want to sell your stock, because the gain is generally taxed at the lower capital-gains rate. That tension is part of every negotiation, and the right structure for your entity can mean real money.
- How the price is split. The purchase agreement allocates the price across categories, and each is taxed differently. Money put toward a non-compete or a consulting agreement is generally taxed as ordinary income to you, while capital-gain items are taxed lower. Do not sign that allocation without your CPA at the table.
- Spreading the gain, and where you live. Taking payments over several years can spread the tax across years and lower brackets, though on a very large note there are traps your CPA will warn you about. And your state of residency at closing matters enormously, since some states take nothing and others take double digits. None of these can be fixed the week before you sign, since they are set months or years earlier. That is the whole reason I keep saying to hire the best accountant and lawyer money can buy and bring them in before you agree to a structure. The right advisor here can save you more than their entire career of fees in one transaction, so work every one of these details with your own accountant and lawyer.
The clean break, or staying on
When I sold Protect A Bed, the buyer's condition was that my family leave soon after, and I chose not to stay and work for the private-equity firm. We took the check the same day. That was a structure decision and it was right for me, because I had worked for myself my whole life and did not want a new boss in my own company. Yours is yours to make, but make it consciously and early, because it changes the deal. If you want a clean break, you need strong cash at closing and a short transition, since you will not be inside to protect a long earn-out. If you are happy to stay, you have more room to accept an earn-out or rollover equity, because you will be there to influence the result.
Chapter 6 checklist
- For every offer, break the headline into cash at closing, seller note, escrow, earn-out, and rollover equity. Never react to the headline alone.
- Make sure the cash at closing, by itself, is a number you could comfortably retire on.
- If you accept an earn-out, tie it to simple revenue targets, define every term in writing, secure the buyer's commitment to fund the business fairly, keep it short, get audit rights, and treat it as a bonus.
- Bring your tax advisor in before agreeing to structure, and at minimum understand the asset-versus-stock question, the price allocation, and how your state taxes the sale.
- Decide early whether you want a clean break or to stay on, and let that choice drive your structure.
- Engage the best deal lawyer and accountant you can find before you sign a letter of intent.