The Definitive Guide to Deal Structuring When Buying or Selling an Online Business
Buying or selling a business can be an exciting, intense, and rewarding experience.
You’ve either spent weeks, months, or years building up the business you’re looking to exit from, or you’re about to deploy a significant amount of capital acquiring one. This is a world we breathe every day at Empire Flippers — the world of Mergers and Acquisitions, or M&A for short.
Of course, we’re typically dealing with businesses below $10 million in value, so not all of the strategies that apply to larger M&A deals perfectly align with deals under $10M.
Yet some strategies certainly ARE relevant within our sphere.
One such strategy is deal structuring.
If you’ve never closed on a deal before, it’s likely you may have never considered deal structures. But deal structuring is the bread and butter of M&A; advantages can be gained or lost depending on how a proposed deal is structured and how the negotiations go down.
This is arguably the most exciting part of buying and selling a business, and likely the least talked about in the brokering space. While everyone is talking about multiples, how to prepare a business for sale, and due diligence, very few are talking about how to actually structure a sale for success.
Let’s change that.
Explaining Transactional Structures — Buying An Online Business
While we normally think of M&A transactions as being one company buying another company, in the online space it usually means an individual buying the business, with the owner of that business negotiating with the buyer on the actual structure of the deal.
There are three main transactional structures in the M&A world you should be aware of: stock purchases, mergers, and asset purchases.
A stock purchase involves purchasing all the stock from all stockholders. Effectively, only the buyer’s entity will own the majority of the stock in the company, becoming the targeted company’s main shareholder. The company remains in tact and the acquirer is taking over all assets AND liabilities in the company.
A merger is where two business entities combine to become one legal entity. The company being purchased gives cash, buyer company stock, or a bit of both to their stockholders during the merge.
An asset purchase, or asset acquisition deal, involves a buyer purchasing just the target company’s assets. The only liabilities that the buyer will have to assume responsibility for are those in the purchase agreement. Since buyers can keep what assets they want and only assume the liabilities they wish to have control over, an asset purchase is one of the cleanest and simplest ways to go about buying a business, especially an asset sale for a business below the $10 million mark.
Every deal on our marketplace is done as an asset purchase, so we’ll be primarily covering this transactional structure below.
Holding Leverage and Balancing Risk
It’s important to talk about risk first, because, whether you are a buyer or a seller, the level of risk you’re comfortable with will determine your approach to structuring a deal.
When you are selling a business, unless you get 100 percent of the list price upfront, you have the risk that the buyer might take your business and not pay you.
If you’re a buyer, you worry whether you’ll be getting the business as advertised — you’re risking that the traffic and revenue won’t be what you were told, not to mention all the other moving parts of a business that you’ll have to manage, like shipping logistics and customer service.
At the end of the day, each party wants to limit their risk. Sometimes the best option to get the deal done is to find a way to split the risk in such a way that both parties get what they want.
A deal structured as an earn-out, where the seller gets paid over a period of time after the buyer has purchased the business, can offer leverage to both sides, making it more palatable to everyone.
The Tools of Leverage
Buyers and sellers can use three tools to gain leverage and help mitigate their risk in a deal structure.
An earn-out is simply where a buyer puts a down payment on a business, takes control of the business, and pays off the remainder of what they owe over a period of weeks, months, or in some cases even years.
It is similar to purchasing a house. Most people do not buy real estate free and clear; rather they put a down payment on the property and pay a mortgage to the bank over a period of years.
An earn-out alleviates some of the risk to the buyer in that they are not investing ALL of their capital at once. They can use their remaining funds as operating capital to help grow the asset they’ve bought. Often the remainder of the earn-out will be paid from some or all of the monthly net profit the business is earning.
Holding the Domain
While earn-outs are good leverage tools for buyers, they don’t do a lot for sellers, which is why a seller should look at holding the domain during an earn-out. By holding the domain, you make sure the buyer will continue to pay until the business is totally paid off.
Of course, this strategy creates some potential trust issues (and additional risk) for the buyer, who might believe the seller will just keep the domain even after the buyer has paid them off.
That is why we recommend three options where a seller can effectively hold the domain without causing any kind of friction with the buyer:
- Using an escrow service that will push the domain to the buyer upon the earn-out being fully paid.
- Hiring a lawyer to act as escrow. This is often a better solution than a normal escrow service, since escrow services are often not fully “clued in” when it comes to how digital assets work. A lawyer will be more flexible while also being able to offer more advice to both the buyer and the seller than an escrow service can.
- Empire Flippers holds the domain until the deal is fully paid out. We actually manage the earn-outs for our customers, which means we also hold onto the domain until the earn out is paid. Once the payment is completed, we go ahead and push that domain to the buyer as part of our migration process.
Full List Price Held in Escrow & Paid on Hitting Milestones
This method provides security to both the seller and the buyer. The seller is comforted knowing the full list price of the business is held safely in escrow, and the buyer knows the seller is going to be committed to making sure the business is a continued success after handing the business off, since the seller will not see the money that is held in escrow if the business does not meet the milestones agreed on with the buyer.
The milestones do not have to be large — they can be quite small, even — but it helps the buyer get enough time to gain confidence in the business and to release the funds to the seller.
Just like when it comes to holding domains, a seller and buyer might serve themselves better by having an attorney hold the money rather than an escrow service. Escrow services can be a bit binary in their decision-making, so they are not always the most useful service for transferring a digital asset. For example, you might buy a website, but once it’s transferred to you the seller may remove the backlinks, causing the site’s traffic numbers to crash. To the escrow service, you got the site, so the seller needs to get paid.
By using an attorney, you can create a much better agreement, one that protects you from such scenarios.
Whether you’re using an escrow service, an attorney, or Empire Flippers, the requirements for the milestones need to be clear-cut and easily verifiable. There needs to be a clear go/no-go option to take the heaviest part of the decision making out of the equation.
The Different Forms of Earn-outs and When to Use Them
Structuring an asset purchase as an earn-out is a solid way to handle a deal, and what we recommend doing.
The most common form for an earn-out is a structured deal that handles financing by the seller, usually over an extended period of time. These kinds of earn-outs involve the buyer putting up a large down payment on the business and the seller “financing” the rest by allowing the buyer to pay it off over time.
This is an easy win for a buyer, since the seller-financed money of the earn-out is almost always interest free. It’s like a zero percent interest loan from the seller.
However, if you are a seller, you should consider offering earn-outs, and then charging interest over the earn-out period. This offers a way for you to reduce the risk of the buyer not paying the earn-out, by allowing you to earn money above the actual list price of your business.
At the end of the day, a seller needs to trust the buyer in order to take the risk of financing via earn-out. If the buyer is someone who is just getting started, or if the buyer seems like someone who can’t maintain the business or take it to the next level, we recommend against this kind of deal structure.
After all, if the business fails, the seller is very unlikely to get the rest of their financed money.
We also recommend that sellers who are completely removed from their business avoid financing via earn-out. The earn-out will drag you back into the business one way or another, even if it is only to collect the monthly check the buyer owes you.
We talked about using third party services as leverage before with earn-outs, but it is worth mentioning it again here. You can use an escrow service or an attorney for more flexible leverage.
One way to structure an earn-out is through the use of milestones. Milestones can ensure the seller keeps providing value to the buyer even after the sale, by keeping them vested in the success of the company.
Typically, milestones involve a monthly/quarterly payment made by the buyer to the seller, but the payment is based on certain goals being hit. The seller doesn’t get paid until the goals are hit.
For example, goals could be tied to things the company is in the process of achieving, such as product that is being shipped overseas finally getting into the warehouse, or a supplier transferring a sourcing contract over to the new business owner.
Milestones might also be tied to the actual growth of the business, either through the revenue or the profits. This structure can be super useful for a buyer if the business is highly seasonal, since the buyer can tie the payout to hitting sales goals the business is claiming to be able to hit during its high season.
Sellers and buyers differ on whether business growth milestones should be tied to revenue or profit.
Sellers want business growth milestones tied to revenue. Since net profit can be manipulated through expenses, many sellers prefer to have milestones tied to revenue to make sure that the buyer pays on time. If the seller goes with profit milestones, they risk running into a buyer that has sudden “new” expenses that cut into that profit and ultimately affect the seller’s monthly payment from the buyer. Revenue is much harder to manipulate in such a way, as it tends to remain consistent even if the buyer is investing heavily into revamping and scaling the business.
Take, for example, a $200,000 content site, making $6,500 per month in revenue, with a net profit of $6,500 per month because the business has no expenses. The buyer and seller agree that if the business hits its revenue goals of at least $5,000 per month for the next three months, the buyer will pay the seller the agreed-upon amount. One month the buyer meets the $6,500 revenue mark, but spends $4,000 on the business, which means a net profit of only $2,500. If the seller had agreed to tie the milestone to profit instead of revenue, they would not have gotten paid, because the net profit was below the $5,000 mark.
Buyers want business growth milestones tied to profit. Using the same example, it’s easy to see why buyers would rather have milestones tied to profit. Our example buyer spent $4,000 investing in the business, on top of laying out a lot of capital to purchase the business in the first place. It’s less likely a buyer’s monthly payment to the seller will create a negative net loss every month if they tie their payments to profit.
This structure is ESPECIALLY true if the business has a lot of expenses, since it takes only a little fluctuation to really sink your profit.
This structure entails the seller selling off the majority of their business to the buyer, but keeping a portion of the business going forward. If a business is growing incredibly fast, this can be a great way for the seller to get some of those benefits while still getting a lot of his equity liquidated into cash.
A buyer can use a seller-retained equity deal to make the seller into a kind of paid consultant that has real skin in the game. The seller and buyer need to make it very clear via a written agreement what the seller’s role in the company is going forward.
This agreement should outline what kind of monthly dividends the seller is going to receive in addition to the price of the business. As long as the seller has equity in the business, they can expect to receive dividend payments even after the purchase price of the business is paid off.
The advantage of this structure to the buyer is having an expert on the team; for the seller, it’s continuing to profit from the growing business. However, it is important to note that it may be very difficult for the seller to exit his equity in the business. Equity is not easily liquidated and often needs to be sold to the owner in order to cash out of the deal altogether.
Balloon loans (more commonly used in Real Estate transactions) can be the ideal style of earn-out structure for 6-7 figure online businesses.
Balloon loans work using an amortized monthly payment, one that will not cover the full loan amount over the life of the loan. At the end of the loan’s period, you have pay the entirety of the loan that is left.
It is important to note that these loans are usually very short-term loans — anywhere from around 30 to 120 days — so it is important to take care of your cashflow if you’re looking to go down this route.
A buyer can use balloon payments to lower the overall monthly payment to the seller by pegging the amortized monthly payments to the growth of the business. The monthly payments would be tied to the business hitting certain profit goals, with the buyer not having to pay the seller if the goals are not met for a given month. While it is a disadvantage to the seller, some sellers might be willing to agree to this if the running of the business itself is capital intensive.
An example of this would be a website that makes $25,000 per month and sold for $750,000, with an upfront $650,000 paid to the seller and the remaining $100,000 to be paid out over 120 days. The buyer is on the hook to pay $3,000 per month to the seller as long the business makes at least $20,000 per month. If revenue or net profit (depending on which one you tied the balloon loan to) falls underneath that mark, the buyer does not need to pay the seller any money that month.
It is important to note though, at the end of the 120 days the buyer will have to pay the full remaining amount of the $100,000, regardless of what the profit or revenue of the business is.
Although both result in the seller continuing to have some stake in the business, an in perpetuity set-up is different than seller-retained equity. For the seller, it means continuously getting paid by the buyer even after the buyer has paid the full price of the business. It includes no continued equity with the company, but rather means the seller is offering some kind of on-going service for the business.
Typically this service is something the seller can do that would be difficult to hire out or involves a skill set the buyer just does not have. It’s a benefit for the buyer to keep the seller on board to handle that service so that the business does not suffer.
The most common example we see is a buyer that purchases a website with private blog network (PBN) backlinks, and they want the seller to keep those PBN links active after the business has been sold to the buyer. Usually the buyer will pay the seller a monthly rental fee to keep the links alive, which is actually a good strategy to mitigate some of the risks associated with PBNs.
While the extra ongoing income is nice for the seller, it is important to realize the seller might have continued involvement with the business for the business’s entire life, which may not be best for the buyer (or seller).
If you’re a seller and are totally burned out on operating your business, then remaining tied to your sold business may not be in your best interest.
But this method is often a cheap way for a buyer to keep the seller “on the hook,” and able to help the buyer with more advanced strategies or knowledge that the buyer may just not have yet, at least until they figure them out for themselves.
Investor & Operator Partnership
Investor and operator partnerships are becoming more common as the online business market matures. Some quality entrepreneurs find themselves with plenty of experience in running online businesses, but lack the cash to make the acquisitions required for exponential growth.
If an operator can find a good investor, though, together they often DO have the skills (and resources) to take those bigger businesses to the next level.
Traditional banks don’t typically offer loans to online businesses, because there are no valuable assets for the bank to take if the business fails and the loan goes unpaid. Operators looking to purchase an online business have to come up with a large portion of cash without the help of traditional financial institutions, at least if they wish to acquire an online business in the high-6/low-7 figure range.
That is where the investor comes in. The operator forms an agreement with the investor where the investor will get paid a certain amount of dividends for offering up the cash. An investor may put down 40%, 60%, or even 100% of the operating capital needed to acquire the business, with the operator providing the rest. (Or using seller financing to make up the difference)
If you’re the investor and you are approached by the operator, the first thing you need to do is make sure the operator has some kind of successful track record in place. The operator shouldn’t have just success with online business in general, but also success with the specific monetization and traffic play that you’re looking to invest in.
The equity can be split between the investor and operator at levels that make sense for both parties. It may make sense in one instance for an investor to put up 80%, the operator to put up 20%, and they split the business 50/50, for example.
While true/traditional partnerships work here, sometimes an investor and operator partnership is much more like an employer and their employee. Larger investors might have teams of operators that they can deploy on every new digital asset they acquire. These investors put up 100 percent of the money for the business and keep the operators on a salary that might have a performance bonus baked in somehow, but ultimately the operator may not have any equity in the business the investor purchased.
Typically, investors are hands-off. That is why they need the operators.
Operators make the day-to-day decisions, while the investor monitors the overall goals. In some cases, the investor will have the contacts or the resources to build out teams and processes that help the operator scale the business further.
While this covers all the seller financing structure, you could also apply these same structures if you went with an outside financing method using a more traditional means of acquiring capital.
Making Deals that Make Sense For You
There are a few things to consider when deciding how to come up with the capital to make an asset purchase, and when accepting an offer on an asset from a seller.
For example, if a seller offers you a better deal on their price if you offer more upfront cash, it is likely better to take that deal rather than doing any kind of financing at all. For example, instead of negotiating $75,000 with $25,000 in an earn-out, you might ask for a flat $90,000 with zero earn-out.
For a seller, getting a guaranteed $90,000 is better than getting $75,000 with the promise of a later payment, and for the buyer, there’s a 10 percent discount on the business.
Since negotiations can happen like this all the time, it is important for both buyers and sellers to set the maximum they’re willing to pay and the minimum they’re willing to sell the business for before entering deeper negotiations. That way you can make sure you always walk away with a deal that satisfies both sides of the table.
Of course, doing a deal like the above doesn’t make sense for the buyer if it is going to put them in a cash crunch.
Remember, there is almost ALWAYS more money to be invested into the business once acquired, so you need something left in the war chest after you acquire the business.
If a buyer wants a longer earn-out period, the seller should try to extract more value out of the earn-out. Say you had a business with a valuation of $700,000. The buyer offers to pay $500,000 upfront and $200,000 in an earn-out over a 12 month period. The seller could ask to increase that earn-out to be above the list price. In this scenario, the seller might ask for a $250,000 earn-out instead, to get above the $700K list price. That would give the seller a 25% return on the $200K in financing and allow the buyer to purchase a business they might not have otherwise been able to purchase.
Often buyers might be willing to add more on top of their earn-out to get the business, so it is worth asking in these longer earn-out situations.
A Quick Note on 6-7 Figure Acquisitions:
For deals in the high-6 to 7-figure range, you will have to come to terms that you will most likely need to accept an earn-out in order to sell your business. Since financing is so difficult in our industry, it is very common for multiple six-figure businesses to use some form of seller financing and earn-out structure to get the deal done.
This whole process is monitored and taken care of by Empire Flippers if you sell your business through us with an earn-out, and we try to keep as much leverage on the buyer as possible to assure that the buyer will pay.
If the buyer seems like he can grow the business, you should not allow an earn-out to stop you from selling your business, especially as it’s often the best way to close the deal.
During an earn-out situation, both buyers and sellers should continue to be flexible with each other as various circumstances arise. Both parties should continue working together and understanding each other’s situations. Sometimes getting the deal done won’t give you everything you had hoped for, but may be better than not selling at all.
Finally, as we have mentioned throughout this article, if you are cash-strapped already then financing the deal may not make sense. If you have to borrow to buy the business and you have zero dollars in your war chest to invest into inventory, potential redesigns, or content, then you’re cutting it a little close. Even after acquisition, your business still needs some kind of working capital to keep going; this is true of even the most basic of online businesses, such as small content sites.
Advantage Can Be Gained If You Use the Right Deal Structure
Whether you are the seller or buyer, you should be seeking to gain an advantage when you purchase or sell an asset. The best advantages usually lie in how you structure the deal.
If you’re the seller, a good deal structuring process could get you more money for your asset. If you’re the buyer, it could make the asset purchase less risky or be far easier to run, depending on the deal structure you choose.
Some deal structures are good for both sides, but in certain cases the deal structure is obviously slanted in favor of either the buyer or the seller. At the end of the day, you need to decide which kind of deal structure makes the most sense for you.
It is important to realize every deal is different, so different deal structures might be more advantageous for some kinds of deals over others. Again, deciding what is best is going to come down to what is going on for you personally at that moment, in addition to what kind of a deal you are working on.
Becoming a master of deal structuring is an art form. You can get good at it and easily turn deal structuring itself into a viable business, and some people have done just that.
Once you become a veteran at using these different tools, you will be able to scoop up more digital assets at better prices with better terms, which will leave you the operating capital you need to take your business to the next level.
Ready to start dealing? Check out our marketplace.
Or if you want more information on what kind of business are out there, check out the most popular online business models.
Photo credit: DmitryPoch