April 26, 2016
Understanding the various ways to structure a deal can be a critical piece to actually getting the deal closed.
While many newbie buyers can get stuck in negotiations, a pro understands how to leverage different deal structures to get the outcome they really want.
Once you get to the meat of what the seller’s really looking for out of the deal, you can structure the deal around their wants/needs and put it in terms that are to your benefit.
In this episode, Ace and I dig into the various types of deal structures, explain how they work, and look at specific examples where they might work best to get the deal done with a seller.
Some of these are well-known (i.e. Seller Financing), but when you use these deal structures in combination (A time-based earn out with in-perpetuity payments, for example) they can get quite complicated.
Our goal is to break each of the deal structures down to better help you understand how you can use them in a negotiation/offer.
For us, this is the fun stuff. Creative deal structuring and finding win-win offers is breathing life into deal deals and can make everyone a ton of money.
Are you digging the podcast? Please stop by iTunes and leave us a review! We love to read the feedback and will give you a shout on an upcoming show!
Ace Chapman: When you’re at the negotiation table. We’re going to throw a lot at you today, but you don’t want to throw a lot at the seller.
Speaker 2: Buying and selling businesses just got a lot easier. Welcome to the Web Equity Show, where thousands of successful entrepreneurs go to learn about buying, growing, and selling online businesses. Your hosts, Justin Cooke and Ace Chapman share their real life advice, examples and expert interviews to help you build and grow your own online portfolio. Now, to your hosts, Justin and Ace .
Justine Cooke: Welcome to Web Equity Show season two, episode seven. I’m your host, Justin Cooke, and I’m here with my co-host, Ace Chapman. Today, we’re talking about understanding deal structuring. This is part of our buyer series where we walk you through, start to finish all the way through buying a website or online business. Good to have you on Ace.
Ace Chapman: Man. This is where I started geeking out, dude. I love structuring deals, trying to figure out how can we get the best ROI on this? How can we protect ourselves from the risks in the deal? So, I’m excited to chat about today’s episode.
Justine Cooke: Yeah, man. Some of the listeners, I know this, but some of the other stuff, it’s kind of, you know, it’s just the business part of it, but this is the fun stuff, and particularly for us as brokers, ’cause we’re helping clients. We’re trying to make deals happen. And so, a lot of times people get stuck, deals get lost because one or both sides aren’t able to find an equitable solution for both parties. Like two sheep passing in the night, they don’t see each other. If only they knew each other were there, they could reach out and they can make a connection. I feel that way with deal sometimes that, just by not understanding the other party, they’re not able to see what they need and how to make the deal happen.
Ace Chapman: Yeah. The funny thing is anytime you’re negotiating a deal, the best negotiators, the best deal makers are trying to figure out a deal strategy that’s gonna work for both sides. I get people all the time, it’s like, “Oh man, you guys do so many deals, you must go in there and just be this hardcore negotiator and try to take as much as you can out of deal.” It’s like, “No, it’s, it’s directly the opposite. I’m trying to get them exactly what’s most important to them out of the deal.”
Justine Cooke: Yeah, and the real way to do that to your side of the house and the other side of the house, what they want, is you really need to understand what the other side needs. I like to think about this like peeling back the onion. So, people tell you what they wanted the deal and just kind of hope you’ll just pass over it and whatever. But if you start to ask, “Okay, so what do you really want and why do you need that? Why do you need the money out?” “Well, I need the money out ’cause we’ve got some projects we want to work on.” “Okay. What kind of projects do you want to …” you’re asking the seller, “What kind of products do you want to work on?”
“Well, I need the money out because we’re gonna have a baby and we want to do an add on to the house.” And we’re just, “Oh, okay. So you need the money to build an add on to the house, to you give your growing family room to grow. That’s the real reason. It’s not because you need the money to do some projects.” Now, I know what you really need. I might even how much you need. And then I can start to work on a deal structure that’s gonna give you what you want and me, what I want.
Ace Chapman: Is those two things is how much you need. And then the other thing is when do you need it? If it’s a project, obviously you’re not gonna spend everything upfront. What’s the actual timeline? And the more information you have, the better it is or the easier it is to figure out and give them exactly what they want. And so, at the beginning you’re also building trust with the seller and so you’re also telling them like, “Hey, here’s what I like about your business. This is why I’m excited about it.” And getting them to open up. You start with that level of trust, it makes deal so much easier to get done when they feel like, “Hey, this guy’s trying to figure out how to make the deal work for him, but also how to make it work for me.”
You can still get deals done with people that you don’t like and maybe they may just be sellers that are miserable people, but it makes it a lot more fun and it just is a lot easier to get a great deal structure that works for both people when you’ve got that trust and likeability factor.
Justine Cooke: Yeah, we’ve been forced with GTLs with people we didn’t particular like or rubbed us the wrong way, but still, looking past that and getting down to what their wants, what their needs are out of the deal, it helped us see it from their perspective and we were able to structure the deal in a perspective that worked for them. In this episode, we’re gonna cover seven different types of deal structures and we’re gonna look at when you should use one and when you should not use one, and give you some ideas. And really, I think this is important because as you’re going sitting down at the negotiation table, it’s good to have these ideas already pre-planned out, already have an idea on what you’re willing to do so that if negotiations get stuck you can lean back on.
So, we’re going to get into this whole episode. Before we do that, buddy, let’s do some listener love. First up, I’ve got a five star iTunes review, buddy.
Ace Chapman: Nice.
Justine Cooke: It’s Lei Ora, left a five star review. Said, “Highly recommended for anyone interested in buying buildings, selling websites or improving existing ones as well as anyone interested in alternative profitable investments. Justin and Ace deliver actual no fluff info in a fast paced no nonsense yet, an entertaining fashion. They’re both an engaging conservationist with great rapport, showing insider info in an industry that’s not so easy to deep dive into.” Well, Lei Ora, I really appreciate your recommendation on iTunes. I’m glad you’re digging the show.
Ace Chapman: Man. That’s awesome to hear folks getting a lot of value out of this. We were pretty hard to make sure that we’re in tune with what people wanna hear and so these five star reviews are awesome.
Justine Cooke: Yeah, it’s fun. I do our podcasts, the Empire Flippers Podcast. We do it for work. I love the show. I love running a podcast show, but you and I, at least in this one are legitimately doing it ’cause it’s fun and we’d love to hang out and talk business and we’re dorks like that.
Ace Chapman: Exactly. We’re just weird is weird enough to love this stuff. We really do want to give people what they want.
Justine Cooke: Yeah, we got a nice shout by Logan on Twitter. He said, “Check out the web equity show podcast with Justin and Ace. Great place to start figuring out how to buy and sell businesses.” So, thanks so much for the shot Logan. I appreciate it.
Ace Chapman: Yeah. Very cool.
Justine Cooke: All right man. Let’s get into the episode. We’re gonna talk about understanding deal structuring. First, we’re gonna already assume … our season two is all about buying websites and online businesses. We’re going to assume that the buyer is already past the initial checks. The buyer has already done their due diligence tests and found out that this is a good listing or a good fit for what they’re looking to do. That’s one of the reasons we’re talking about deal structures today.
Ace Chapman: I love doing these deal structures. It got several things. The thing that I want to, as a disclaimer, talk about before we even jump in is when you’re at the negotiation table, we’re gonna throw a lot at you today, but you don’t want to throw a lot at the seller. As you’re thinking about some of these things, you still want to come up with something that’s gonna be simple for them to understand because hey, as crazy as it may be, they may not be fans of the show and so they may not know what in the world you’re talking about when it comes to some of these things.
Justine Cooke: Yeah, man. You’re totally right. We’re talking about seven different deal structures. If you walk into a negotiation table and you’re like, “Oh, we can do this, or we can do this, or what about number four?” And they’re like, “Ah, I don’t …” It’s bad. You don’t want to give too many options. In fact, the less options the better. You want to have these options in your tool belt, but you don’t want to just go out and start hammering them with all the different options, giving them some analysis process. Yeah, that’s a really good point, Ace. Let’s talk …
Ace Chapman: Yeah, so what we’re doing today, we want to make sure you got all the different options before you’re at the negotiation table, but you want to be the filter to figure out based on this seller what they want and need, how you can really structure the deal in a simple way that meets their needs.
Justine Cooke: All right, man. Let’s roll it out. Number one is seller financing. The question is when should you use seller financing from a buyer’s perspective? Honestly, you should use this whenever you can get it. If you can get it at no interest rate or an extremely low interest rate, you should always do it because here are your options from a buying perspective. I pay, let’s say 100% cash upfront or I pay 100% of the business out over six months or 12 months or 18 months or 24 months. The second option is better, like always. If I don’t have to put the cash upfront, I’m putting the same amount of cash over a period of time, that’s a better option for me.
Now, a lot of times, you and I were talking about this before the show, a lot of times they’re not going to take 100% finance over 12 months. That’s a no go almost all the time. So, all that would be great from a buying perspective. It’s not realistic from a seller’s perspective. But what you do is, let’s say you offered 60% upfront and 40% over a 12 month term, they may not take that, but they may take 70% with 30% over a six month term. Right? And even that is better than 100% cash upfront.
Ace Chapman: Yes, it is. The truth is you’ve got to balance the risk. So when you’re looking at the seller financing thing, just like you don’t want to put 100% of the cash immediately upfront and give that to them because that means you’re taking 100% of the risks, you can’t expect them to do 100% financing because then they’re taking 100% of the risk on you. And so, balancing that out a bit is where you really want to be when it comes to just a seller financing. The other awesome thing about seller financing is 90% of the time we don’t pay interest on this. It’s very, very rare that a seller even mentions trying to charge interest on the seller financing.
Justine Cooke: Yeah, that is weird. You’ll see that on much larger deal sometimes, but definitely not on like the low six figure deals, you just don’t see that very often and they’ll for some financing to you for virtually free. In that instance, when it’s free, you should always absolutely take it. Now, let’s talk about when you should not take it. You shouldn’t take seller financing if they’re willing to offer you a better deal on cash upfront. For example, you know, I offer 70% upfront, 30% out over 12 months, and they say, “Ah, I don’t know, and I come back with an offer of, say 90% cash. And they’re willing to do the 90% cash. They liked that better. I’ll take 10% discount to put the cash upfront or 15% or 20% discount. So, you need to work out what that is, but if they’re willing to give you a big enough discount on the cash upfront, that might be worth it for you.
Ace Chapman: Yeah, and the other thing to think about when you’re looking at that is obviously your cash, if that’s going to put you in a huge cash crunch, it may be worth for go in the discount. So, you got to look at your situation and just figure out, hey, what makes the most sense for me?
Justine Cooke: All right, man. That one’s pretty straightforward and pretty easy. You should take that almost all the time. It’s too easy. Let’s talk about another scenario, which would be earnouts. This one’s meaty. So we’re gonna step through this carefully because there’s so many different options here. When we talk about earnouts, there’s three different ways to think about it. Number one would be milestone based. This could be tied to hitting certain milestones or certain goalposts over the next three, six 12, 24 month period. If this happens or it could be tied to revenue, it could be tied to property, non financial Issues. It could be growth of the business or whatever.
The second piece would be profit-based earnout. This would be an earnout that’s tied to net profit. So, say to get to 100% and value, it’s $24,000 over 12 months. So, you’re gonna everything that the site makes $5,000 a month. And profit, you’re gonna give 40% of net profit to the seller over 12 months. And so, 40% would be $2,000 a month and that’ll get you to the $24,000-ish depending on the net profit. So, if it goes up, they get more. If it goes down, they get less. You could also do it where its revenue based. So, instead of tying it to net profit, you tie it to gross revenue. So, no matter what, on the $5,000 or whatever, let’s say it’s making $6,000 you’re giving 33% of gross instead of 40% of net, if that makes sense.
Ace Chapman: Yeah. And when it comes to the revenue and the profit, the key there is obviously the profit number may be a little bit higher. You got to have that revenue number in line with where the profits are to be sure that you’re not paying out too much or paying out all of your profit or even more than your profit when you’re structured as a revenue based deal.
Justine Cooke: Yeah, and you can tie these things together, so they can be a mix and mash of these different types of earnouts. Let me give a scenario. Let’s say that there’s a business making $10,000 a month in net profit. Let’s say you bought it for $200,000, 20 acts, just to make the math easy. You can give over a period of time, let’s say you’re giving out 50% of net profit, but only if the gross is over $7,000 a month. So, basically they’re gonna get 50% of net profit, but any month where it drops below $7,000 you give them nothing. And so, that can be based on a 12 month period. Let’s say for example, it’s above $7,000, 10 months out of the 12, where you’re only paying them some amount of money in those 10 months.
Or it can be tied to a total dollar amount. Let’s say you owe them $50,000 no matter how many months it takes. If it takes, you only do six times in the first 12 months and they’re paid out some money, then there’ll be some period of time that it has to break that $7,000 and then they get their 50% until they’re paid the total of $50,000. We’re doing this on a podcast. Its be a lot easier to write that out, man. But basically, it’s tied to whether you break certain tiers are milestones and then its profit share only.
Ace Chapman: Well, the thing when you’re structuring these is knowing when to use these. You could go to the nth degree and all the different possibilities, but the example that you just gave with paying it out over a certain dollar amount, we actually just structured a deal that way, actually one with you guys that way.
Justine Cooke: Really?
Ace Chapman: Yeah, we do that quite a bit. When we use that is when the deal is growing a lot. So, the deal is on an uptrend, but historically it hadn’t been that great. You know what I mean? And this is also a good tip for sellers. It is great to sell a business that’s on the uptrend cause it’s gonna pull buyers, and especially when you’re willing to negotiate and that kind of thing. So, we love buying the businesses that are on the uptrend, but we don’t want to necessarily pay for the most recent income increased immediately. And so, what you can do is structure a deal where you got a little bit of the earnout on the amount at the multiple that you want to buy the deal at. And then, over a certain amount of the business makes more than the 7,000 like you were mentioning, then they get a bigger lion share.
So, it may be 20% of revenues under 7,000, then we get over 7,000 and we’re willing to do 50% of that because that’s bonus income for us.
Justine Cooke: Yeah. Again, you can tie that to a total dollar amount. We’ll do this deal until the seller is paid out a set dollar amount or you can do it for maybe a set period of time. We’re only doing this first six months or 12 months or whatever. So, you can go both ways on that. And the risk is just gonna be dependent on where it’s going and where you as a buyer feel it’s going. So, I might do the total cash payout. So, I might set a dollar amount if I know that or if I think that there’s some risk that’s gonna get worse.
I think it’s a fair risk that it may get worse or make it significantly better. I’ll do that just the total dollar amount. Maybe I don’t want them to share in the upside, but I don’t want them to continue to get paid out if there’s downside and I’m not making as much money as I thought. I may do a set period of time if I see like really long-term growth in the business and maybe it’s gonna be okay this year, but the work I put in over the next 12 months will significantly grow it over time. Sure the seller gets paid some money, but most of that extra growth in the long term is going to be mine.
Ace Chapman: So, the other time they use this is when you’re in the deal that has a high seasonal variance in the income. So, you may be coming out of high season, you want to make sure that eventually it does get back up and you want to focus on structuring a deal around that. The other side of this is that when you got a deal it’s just a little bit riskier. It can be a deal that maybe isn’t as older, hadn’t been around as long. You don’t know how well it’s gonna do or not do and so you wanna really focus on using one of these earnout structures.
Justine Cooke: Yeah, I think a high risk reward scenario, and especially if the seller is pushing “Oh, it’s gonna do great, it’s gonna do great.” Okay, we’ll talk earnout then. Why don’t you share in my upside. I’ll give you some share in the upside if it’s gonna do so well, but I want you to share my downside if it doesn’t too. Talking about when not to use earnouts. So, I wouldn’t use a profit based earnout on a business that has moderate to high costs. So, eCommerce businesses are a good example of this, where your cost of goods is relatively higher, a drop shipping business in particular.
The reason what this is, why not use profit as a buyer? Like you’d say, well, the base in our profit would be better. Because you control the costs and I can make the profit whatever I want it to be. The problem is it just gets too messy. It’s really messy trying to based on net profit, and maybe order a bunch of inventory. Now, there’s dispute. You’re relying on contracts and you know both sides are not terribly happy with the deal. It can get really messy. So, I wouldn’t use it when there are moderate to high cost. I wouldn’t use a profit only based earnout.
Ace Chapman: Yeah, and it has to be that way.
Justine Cooke: We ran into that. Actually, you and I ran into that on a deal. There was a dispute between the buyer and seller on that. It was a profit based deal where there were high cost. Yeah, we did that.
Ace Chapman: Yeah. We had to come in and try to work it out between them. That goes back to having just doing deals with good folks and that kind of thing. And both of guys on both sides of that were good guys. So, it was just getting them together and figure out, okay, let’s look at this. You gotta be willing to be an open book when it comes to these deals or there’s gonna be disputes.
Justine Cooke: Another situation I would want to use a profit or revenue earnout is if I plan on making serious changes to the business right after purchasing it that will result in relatively high growth in the short term. The reason I want to do that is because I’m putting all the work in and they’re gonna get all this additional value. If you’re gonna do that, tie it to a specific dollar amount. Okay, maybe they get paid off faster, but ultimately, I return that value long term. Yeah, they may get paid off and we’ll do profit share, but only up to a certain dollar amount. We were expecting that dollar amount to take 12 months to reach. We reach it and seven months, great, seller’s out of the deal and I get to collect my rewards.
Ace Chapman: Yep. As we talk about some of these other things, you can tie those into this type of structure to make it even more appealing to the seller.
Justine Cooke: All right, let’s talk about the third structure, which is a whole or a balloon loan. Basically this is the deal where you’re gonna pay some amount, like a higher, let’s say 70% upfront and you might pay 30, 60 or 90 days, you’ll pay the additional 30%. And this may come after training. A good time to use this is if there’s a significant amount of training that needs to be passed on from the seller to the buyer. So, there are multiple moving pieces or the buyer’s particularly new and needs to kind of get up to speed and they want that assurance that that seller is gonna get them up to speed by holding back the cash. Or when there’s turnover, there are some contingencies that are really important.
Say for example, I’m buying a business and for whatever reason we can’t tell the employees. We don’t want to tell the sellers, we want to tell the employees. Okay, but if the business is really reliant on those employees come along with the deal, I can do a holdout that’s contingent on that employee staying on board for 90 days. So, we’re not gonna tell them beforehand, we do the deal. It’s contingent on an employee staying on board, if they stay on board, you get paid. If they don’t, you don’t.
Ace Chapman: This is exactly what this is great for. So. you want to use this on those contingencies situations. Sometimes it could be, like you said, it could be the training period, it could be employees, it could be a deal that’s about to close. We’ve seen, we’re buying a business, it’s in the middle of something that could be really huge for the business. And the seller may be wanting to get paid a little bit for that or they feel like, man, there’s just big potential and you will only have two options. Either you wait and maybe rest losing the deal or whatever or you structure it this way.
So some of the times not to use this is again, when you really don’t need it, there isn’t that contingency situation. There isn’t that deal that’s kind of in the waiting room. You can get into that deal and safely buy the business as it is. And so, if you can do that and get a really great discount on a deal by not having this a balloon payment or a hold back, and sometimes people will call it on these shorter terms and get into the deal and actually save a little bit of money, especially if all you’re gonna get, it’s like a 30 day balloon. There’s not a huge financial benefit to having a 30, 60 day balloon. The only reason to have that is because of a contingency.
Justine Cooke: Yeah. So, if you don’t need that contingency, you don’t need employees staying on. It’s pretty straight forward to Amazon affiliate side. I own a few already. I don’t really need that balloon deal. I may ask for it. I may ask for 60 days, 70% upfront, 30% over 60 days and then say, “Hey, or I’ll just do cash upfront, 95%.” To save myself a couple of bucks. It’s a way to get out of it. Now, this is sneaky, so I am not sure I wanna mention it. I don’t want people using it against me, but you know what I mean? I think about this stuff. One of things you can do is, we talked earlier about peeling back the onion. Let’s just say I know that the seller needs $90,000 to put down this house they’re … him and his wife looking to buy or whatever.
I can offer deal like, “Oh, over time we can do $70,000 upfront. I can do it $30,000 in 90 days or 60 days. I’m like, “Oh, we want the money faster.” “Okay. Great. I’ll do $90,000 upfront. They’re willing to take it. They need the cash to buy the house. That’s a little zero sum, I win you kind of win positions. Once you actually know the reason why the seller’s selling, what they need, you can structure the deal in a way that they get what they want, they get what they need, but you give yourself a discount on it as well.
Ace Chapman: Yeah.
Justine Cooke: All right, man. Fourth thing we’re gonna talking about are the in perpetuity payments and we’ve seen these deals. We’ve had bars off these deals. We’ve had seller take … let me just kind of explain what that means. You would use one of these in perpetuity payments when there are some continued work that needs to be done by the seller or when they need to keep like let’s say PBN links going to the site. So, say I’m buying $100,000 business and I agree to continue to pay the seller forever 200 bucks a month or whatever, as long as those links from that PBN stay in place and whatever. The site retains certain rankings or whatever.
I could do something like that or I’ll call continue to pay you. It’s a good time to use this. I think when the seller, no matter how you’re gonna work the deal, they’re gonna have some leverage over you, they keep some kind of leverage over you where they have the PBN or they have the PBN, they’re gonna keep the links themselves so they can point it or not point it to you or they have some kind of like specialized knowledge that it would be hard for you to learn or hard to hire for and you really just want to keep them around for that knowledge. So, you’re gonna pay them in perpetuity based on that knowledge or based on keeping the links in place or something like that.
Ace Chapman: Yes. That’s one of those things where we’ve seen people will try to charge you. We’ve seen people come back to like charge the ones that weren’t negotiated. So, as much as people may tell you, “Oh, we’ll just leave these up. We’ll leave up the links or we’ll continue to do this work.” It’s to die down. It’s like, “What have you done for me lately?” A year later they start thinking like, “Man, this is another way I may be able to get some cash and why am I still doing this work on the deal I sold a year ago?” Way Better to get that negotiated upfront.
Justine Cooke: Yeah. Another thing too is when you think about it, let’s say that there’s about 10 hours of work a month that needs to be done on the deal. And I’m coming to find out they’re willing to do that 10 hours of work for 300 bucks a month. Now, that’s 30 bucks an hour. It may take you more than 10 hours of work, plus maybe your time’s worth more than $30 an hour. They’re happy to do it at 30 bucks an hour, you’re not. So, it’s a way for you to keep them on and keep them working on the business, especially if that work is valuable and worth it to you. So, if you’re getting a positive ROI on it, like I know that I couldn’t hire someone to do this for 30 bucks an hour, I couldn’t hire someone as good to do it, and the seller sounds excited and happy about doing it, why don’t I keep them on and have them continue doing the work and you’re getting a good value out of it.
Ace Chapman: Yeah.
Justine Cooke: I think the time not to use this is when the seller doesn’t really provide any value post sale. Like you’re buying a deal, you’re gonna take it over. There’s no real reason to keep them. They don’t have any leverage over you and you’re not getting a positive ROI by keeping them on board. Don’t bother with it.
Ace Chapman: Yeah.
Justine Cooke: All right man. The fifth thing we wanna bring up is outside financing and there are just a ton of ways to do this and we’ve talked about this in other podcasts, I’ll just mention a few of them here. This would be things like bringing in [Lendvo 00:26:25]. This would be things like hard money where you can use credit cards, you can use personal lines of credit, you can use home equity lines, you can use crowdfunding options. You can use friends, family fulls, you can use investors, you can use SBA loans. There’s lots and lots of ways to bring an outside financing and to get a deal done.
Ace Chapman: Yeah, the key here is, all these options are gonna be tied to your personal credit. That means you’re personally liable, they can come after you personally, no matter what happens with the deal. We weren’t sure about Lendvo, but I think you have to sign personally with them as well.
Justine Cooke: I think so. I’m not sure. But yeah, I think so.
Ace Chapman: Yeah. So, unless you’re dealing with investors or you get friends and family that are doing equity, then you’re gonna be still labile regardless of what happens with the deal. So, equity is always a lot nicer option on some of these.
Justine Cooke: Yeah. Not everyone. This isn’t for everyone. So, someone was like, “Oh, I don’t want to be borrowing too. This is crazy.” If you are okay with that, if this is a risk you’re willing to take, you’re really gonna use this when it’s available at a lower interest rate. So, if you’re willing to get a low enough interest rate where it makes sense, the returns on online businesses and websites can be fantastic. So, basically you’re just leveraging to get a better return on the business by borrowing money and paying a very low interest rate. Another reason to use this I think is you have the cash, so you’re buying a $200,000 business. I have the $200,000. I don’t want to put a lot extra into it, but I know that this business is, let’s say inventory dependent. It’s a kind of a cash cow.
I want to add a bunch of inventory. I wanna I make these moves and I don’t wanna use all my cash and then have additional cash I need for it. I can borrow the money, make sure I get the loan so that I can go into the deal, set up our half of our $100,000. I can purchase the business and know I have $100,000 to do the things I need to do. If I don’t get approved for that loan or I don’t get that money beforehand and I’m not able to get it after I’m in a bad position. Because I’ve now bought this business and I can’t get the capital together to buy the inventory or do a redesign or whatever the business is going to need to grow.
Ace Chapman: Yeah. That also ties into when not to use one of these is when you’re completely cash strapped. If you’re gonna go out and borrow some money and it’s going to leave you 100% cash strap. Even after you bought all that money, that is a time not to do this because you’re still gonna need additional funds for inventory. The things that you mentioned redesign, going out and driving more traffic, testing some other things. I think a lot of people get so focused on buying that they don’t think about running, and you need cash in the bank. Just day one, you can’t buy the business and day one just have zero cash or negative cash in the bank.
So, you want to figure out how much are you going to need that makes you got that. The other time not to use this is when you can’t deal with the risk. Being an entrepreneur is risky. Buying these deals, we love them, we feel like it’s a lot less risky, and we’re starting from scratch and getting along from that, but it’s still risky and if you get into one of these deals and it goes bad, you need to be in a position that you’re gonna be able to continue to that regardless of what happens with the deal.
Justine Cooke: Yeah. I think it’s scary. That’s funny to me actually, Ace is that if someone’s buying a restaurant, they’re buying a restaurant. I can’t imagine myself ever buying a restaurant, those businesses scare the hell out of me. But just saying someone’s buying a restaurant, they’re not gonna spend every dime of their money buying that restaurant and have no money to pay employees the next month or do whatever. They understand they’re gonna need some cash for the business and not just the cash that’s being created by the business. They’re gonna need some kind of buffer, but people don’t feel the same way about online businesses and they really should. They should think about, okay, I’m gonna need some cash for inventory or some paid traffic tests or to do a redesign or to hire a VA. I’m gonna need some additional cash.
So, don’t blow everything on just the business. Don’t get the exact top, last dollar spent on a business because you’re gonna need some additional costs. I think that’s a really good point. All right, man. Let’s move on to number six, which is seller retained equity. And this is a deal where you’re buying the business, seller wants to keep a piece of the equity long term and along with that you’re going to get a discount on the business. And a good time to use this is when the seller is unsure about selling. So let’s say for example, they’re not selling, they’re not listed with a broker or they weren’t planning to sell. Someone you reached out to or it’s a friend or a peer or a connection of yours and you’re talking to them about potentially buying their business, but they’re just unsure about it.
They’re not Gung Ho about selling. They didn’t put all this stuff together to list and sell it. Maybe they’re coming into high season or they’re in a particularly heavy growth curve. They’ve done 20% after 20% after 20% each month and they’re like, “I don’t know, I’m really crushing it right now.” This may be the piece, the carrot you can dangle that will get them to close the deal. Another time to do this I think is if the seller provides some long-term value. They’re gonna basically be in a limited partnership with you. Maybe they keep 20%, but you’re able to get a 30% discount on the business and they provide plenty of long-term value or it’s the carrot that gets the deal done. I think those are some good situations.
Ace Chapman: Yeah. And there are a lot of times that you just don’t want to deal with this. And you want to think about the long-term cost to you. So, one of the times not to use it is when it’s a smaller deal, it’s just not worth the hassle.
Justine Cooke: Seller retained equity on a $40,000 Amazon affiliate purchase is just not worth it. It’s just not worth it. Don’t do it.
Ace Chapman: It’s not worth it.
Justine Cooke: I don’t think the seller wants it. Pay a little extra to have them not do that. Just don’t do that.
Ace Chapman: Yeah. I mean, you’ve got this person, you’ve got to get them their portion of the money. You gotta do the calculations. You gotta make sure that it’s all right and they’re happy with the calculations that you came up with. Maybe they don’t like the way you’re running the little side or you’re not doing enough to it because it’s not worth your time. Just endless, endless, endless problems.
Justine Cooke: There are some liquidity issues for the seller too. Okay, so they keep 10% or they keep 20% or 15% or whatever. How do they ever get out of it? Do they ever get their cash back out? Even if it grows, when are you gonna sell? That’s really under your control so it can get a little messy and you particularly don’t want to do this deal if you don’t want to work with that seller. If you guys rubbed each other the wrong way, they’re not the type of partner you could see yourself with. It’s just you’re just not all that interested. And even though it may sound appealing, even if you could take a 30% discount and only give them 10%, 15%. You’re like, “Oh, that’s a pretty good deal.” You’re gonna have to continue to deal with them. That may not be something you don’t want to do. If your gut tells you it’s not a good idea or you just get a bad vibe, don’t do it.
Ace Chapman: Yes, that is absolutely … I just prefer on most deals to avoid this.
Justine Cooke: Yeah. One thing you can do though too is, is you can mention it, bring it up. If the seller was nervous about doing the deal and then maybe this is the thing that pushes them over the top and then come back with maybe a little more cash right now. You want to get them in the mindset. You want to get the seller in the mindset if they maybe open a selling, but not really stoked about it. Get them in the mindset of selling and then you can, “Oh, maybe I’ll give you a little more cash upfront or whatever. I’ll buy you out a little earlier.” And then they do the deal anyway.
So, again, we’re talking about doing a deal that you’ve already checked, you’ve already done your due diligence on, you know it’s a good fit for you. You’re just trying to get the deal done. So, by throwing these options out there, it might get the seller to move, which is what you’re looking for. And with seller retaining equity, always, always, always include a buyout option if things go sour. So, include that in the contract. Maybe you have to pay a little more whatever, but give yourself that peace of mind where you can get them out at some point in the future, even if it costs a bit more, have that option.
Ace Chapman: This is something you really want to do in a lot of equity deals, especially when you’re doing these small ones because it can make sense if you’re going out and you’re raising capital, it can make sense to take some capital on a small deal. But even if you’re doing that and you’re gonna go out and you’re gonna build this portfolio and do multiple deals, it helps to give both people an out and you’re planning for that worst case scenario.
Justine Cooke: All right, man. The seventh and final one we’re gonna talk about is the investor sweat equity partnership. Now, I like this one. I think this is really interesting and this is for people that have the skills, but maybe they haven’t built up the cash at themselves. They’ve got some skills, and they’re even running sites, but they want to scale up. And here’s just kind of example of what you could do. Let’s say you have an investor, you have your uncle, you have your cousin, you have your mother, whatever, put in 80% of the cash. So, it’s $100,000 business. They put in $80,000, you put in $20,000 and you split the business, 50-50 or 60-40. You’re going to do the work. They’re strictly a passive investor, but they’re putting up more cash than you and you’re buying in by putting in the sweat equity into the business and actually running the business for them.
Another of way you could structure this, and there’s obviously a million ways you could do this, but you get 100% investment from two different investors. So, one investor puts in 50, one investor puts in the other 50 or 60-40 or whatever, and then you do the work. So, you’re going to be the one running it. You’re going to be the one maintaining it and you retain 30% equity in the business. They split it up due to their equity position or their capital position based on where they’re at. So, I think this is great for someone who has got the skills, has proven themselves out a bit. They’ve done this a bit already and they’re looking to move up quickly, quicker than they could by just saving up the capital themselves.
Ace Chapman: Yes. In all these things, what this allows you to do is make your money go further. And this is another one of those guys where not only can you make your money go further, but you could make no money go further, but there’s still some times that you don’t want to use it. So, a lot of times going back to the family and uncle and all of that. You don’t want to ruin relationships with people that are close to you if things go south. And so, there are two ways to deal with that. Number one, is just not to deal with people that may be investing in the deal just because they love you and they know nothing about the business because that’s just a recipe for disaster. They don’t know what they don’t know. So, as soon as things go bad, it’s just like, “Oh well, it must have been something you did. What do we do?” So, that can avoid it.
The other thing is just being very, very upfront with the risk and the fact that this could go south and don’t put money into this. That is your life savings. And so, the more that you’re giving those disclaimers, if you’ve ever read a PPM or perspectives from a company raising capital from individuals, there’s disclaimer as a disclaimer and warning and warning and just goes on and on. And that’s required to be in there so that really protection for you. If things did go south, it’s like, “Man, we gave you this warning and that warning and you signed this.” There’s really nothing that you can say.
Justine Cooke: Yeah. If you can’t deal with the awkward Thanksgiving table conversation with uncle Pat who gave you $80,000 for the business just don’t do the deal. If this is gonna cause any problems in your family because of it or whatever, that’s probably not a smart move. And the other thing is, you’re worried about them, but you’re also worried about you, and the family and the awkward positioning. There’s another thing too where if you’re going to do the deal, as I said before, we’ve got to investors, they’re putting in 50,000 each. That’s 100,000 business, you’re going to keep 30% of the equity. $100,000 business and your 30% piece, for example, let’s say that it made $40,000 a month in profit. At 30% and you’re only making … I’m sorry, 4,000 a month in profit, you’re only making 1,200 bucks.
If you’re gonna be running that business and requires a significant amount of your time, effort and energy, and you’re only making 1200 bucks, it may not be worth it for you. So you need to think about your equity position, the amount of profit that gives you a month and see if the work and the effort is worth it. A horrible situation is where you do this and you realize, you know what? I don’t want to run this anymore. I’m getting a bad ROI, I want to let it die. And now you got these investors who can’t run the businesses, they don’t want to run the businesses. They don’t know what to do with that. And obviously you could sell the business and that’s what a lot of people do, but don’t put yourself in a position to where if it did well, if it was cruising along, you wouldn’t be happy with where you’re at.
Ace Chapman: Yes, and people get so excited to get their first deal done, which is, it’s admirable, it’s fun. You want to get a deal done, but it’s a nightmare on the backend if you get in there and it’s not a good situation for you.
Justine Cooke: All right, man. Let’s do a wrap up on this episode. I really liked the deal structuring stuff. This was really, really fun for both of us. We’ve done a lot of deal structuring. I know we’ve done some deals structuring with you as we talked about in this episode. I remember some of these deals. To do a wrap up, I think it’s really important to know these types of deals before you go into the negotiation table or go sit down at the negotiation table, and that’s what we’re gonna be talking about in the next episode next week, we’re gonna talking about how to work the deal out with the seller, negotiating tips and tactics. I think that’s really interesting.
I think understanding these different deal structures and what you have available to you is important as you go into this. So, as we said at the top, you don’t want to mention all seven right up. Which option do you choose? Because that can be overwhelming and it’s ridiculous. First you need to find out what they need or want, peel back that onion and then use maybe one or two of these to help them kind of get what they want.
Ace Chapman: Yes, and you need to understand as the buyer, and this season we’re really addressing the buyers pretty heavily. As a buyer you need to understand that you have to take control of what the deal structure is. It’s not the seller’s job to tell you, “Oh, this is the offer that you need to make to me and this is the deal structure that I’m going to go for.” They want to wait and see who’s going to give them the best offer. And this can give you an advantage to being able to structure a deal that gives them what they want as opposed to trying to focus and just buy the deal at just a low price.
Justine Cooke: That’s right. I think you, as you’re considering us and prepping to make an offer, you need to think pretty clearly and carefully about your risk and your downside here. You don’t want to put a deal structure in place that’s not to your benefit because you thought it sounded cool. So, you really need to think this through beforehand and know what you’d be willing to offer and wouldn’t. And then, as the negotiation goes along, you have those, and you can lean back on them and introduce them.
I think it’s also important too when you’re, and we’ll talk more about this next week, but when you’re presenting the offer, you want to put it in terms that highlight the seller’s benefits. It’s really funny to me. It cracks me up when we’re negotiating a deal and this could be as brokers, this could be with vendors of ours, whatever, and we’re negotiating a deal and they talk about the deal from their perspective. They’re like saying, “I want this or this is what I think.” That’s just such a bad way to negotiate because you put the other side in the defensive. You put the other side in an untrustworthy position. You cause some antagonism. It’s way, way better to put a deal that is beneficial for you in terms that it’s beneficial for them.
Ace Chapman: Yes, it is. That’s what we’re trying to get to. Obviously we’re gonna get more into that on the next episode. So, these two combined could prepare you for your first negotiation.
Justine Cooke: Yeah. The Art of the deal, buddy. To rewrite the buck.
Ace Chapman: Yeah.
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