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Industry Insights

Small Business Private Equity: What to Expect and How to Choose the Right Partner

What is Small Business Private Equity?

Small business private equity follows the typical private equity model: private equity firms, or investors, buy a company and then grow it to prepare it for a later sale. The difference is, small business private equity firms focus on acquiring smaller companies— businesses typically in the range of $1 million to $4 million EBITDA or $5 million to $20 million in annual revenue. While larger private equity firms would not consider a transaction this small, they might if they are using it to add on to a company they are already invested in.

Do Private Equity Firms Buy Small Businesses?

Yes, small business private equity firms focus on buying small businesses, or businesses in the range of $1 million to $4 million EBITDA and $5 million to $20 million in annual revenue. While small businesses may seem undesirable for investors, the right business has lots of opportunity to the right purchaser. Private equity for small business investors seek small companies with great growth potential, as they have a high chance of improving that company’s value and therefore selling it for a higher purchase price later. This is the common private equity strategy.

What Types of Small Businesses do Private Equity Firms Look for?

Small business private equity firms seek promising small companies with high growth potential: in other words, stable revenue, ability to scale, strong market presence, and clear areas to improve. Strong management teams are also a plus. While stable revenue and a dominant market presence demonstrate past success, the ability to scale makes future growth likely. This combination is exactly what small business private equity investors are looking for.

So, what does a company’s ability to scale look like? For example, new equipment to be purchased, software upgrades to be made, a new geographic location to expand into, and more. These opportunities are often obvious to a potential investor and make the deal desirable.

Factors Private Equity Firms Consider When Acquiring Small Businesses

In addition to a company’s growth potential and stable past revenue, a private equity firm buying a small business looks for a wide, loyal customer base, and the high likelihood of a clean exit strategy after ownership. Since most private equity firms—even small business private equity firms— are looking to grow a company and then later sell it to make a profit, investors are often assessing the profitability of a future sale.

However, not all small private equity firms are created equal, and some firms prioritize long-term company health over making a quick profit. 1719 Partners, for example, is a long-term investor that takes company ownership as seriously as many family-run business owners do.

What is the Small Business Private Equity Process Like?

When a private equity firm is interested in a company, they will first reach out to the prospective company. Sometimes this introduction is made via an intermediary whose goal is to connect a buyer and a seller. From there, the buyer will conduct a formal business valuation. If you are curious what the value of your business may be, you are welcome to use our easy and free business valuation calculator.

When the business sale process has seriously begun, both parties voluntarily execute a letter of intent. This agreement sits between more casual interest and a finalized purchase agreement. Post letter of intent, the due diligence process begins: the small business private equity firm investigates the company to make sure financial statements are accurate, the facility is clean, reliable employee policies are in place, and more. This due diligence process is time-consuming, but it is required and is also an opportunity for the seller to showcase how valuable the company is.

After the due diligence process has completed, both parties move toward the final close.

How Do Private Equity Firms Value Small Businesses?

A small business’s valuation depends on many aspects, such as the company’s competitive landscape, EBITDA multiple, revenue, and growth potential. The EBITDA multiple is a very commonly used valuation method for small private equity firms. Simply put, an EBITDA multiple is the factor multiplied by a company’s EBITDA that yields the company’s enterprise value (valuation). While many factors increase the EBITDA multiple, the largest ones are a company’s growth potential, competitive landscape, and financial performance.

As discussed earlier, increasing growth potential, financial performance, and market presence leads to a higher valuation. The EBITDA multiple just captures these themes in one convenient number: the higher the multiple, the higher the company’s valuation.

What Does a Private Equity Deal Look Like for a Small Business?

Small business private equity transactions are often owner-focused, ensuring the previous owner’s personal and financial goals are met. This can look like the previous business owner remaining more involved in the company than he or she would be in a transaction with a larger private equity firm. For example, small business private equity transactions offer recapitalization, where the owner sells part of the business, remains a partial owner, and then when the company is sold again later, they receive additional proceeds. The structure allows the owner to effectively “sell their business twice” while slowly phasing out of ownership.

Larger private equity firms are typically less focused on the previous owner’s goals and offer less options to share ownership going forward. At 1719 Partners, we offer flexible deal structures to meet the owner’s goals while preserving their mission for the company.

Is Selling to Private Equity a Good Idea?

Selling to private equity is a smart option when you want growth support, a solid business transition plan, or flexible ownership going forward. The right private equity partner might even prioritize your company mission after the sale while meeting your financial goals for the exit.

For example, if you run a family business but lack a successor for the next generation, a private equity firm can step in and help find a new management team to replace you. At the same time, if you have a successor picked out but he or she lacks the capital to fund your exit, a private equity partner can help make these financial and personal goals a reality – for both you and for the successor. In addition, sometimes businesses need additional capital or resources to grow. Private equity firms can offer this growth financing as well as a wealth of resources and connections to take your company to the next level.

Slowly phasing out of the business is a great way to help your business uphold your founding mission, even as new partners hit the stage. It is also a nice way to “say goodbye” slowly to your company. Partnering with private equity offers these options.

How to Choose the Right Firm

It is important to find a small business private equity firm that has the capital and expertise to make your goals a reality, as well as one that aligns with your business vision. Vetting the firm is important: have they completed many successful transactions in the past, have previous business owners been good references, and have their acquired companies performed well? Exploring the private equity firm’s website can give you a good idea of their expertise and accomplishments. Having initial, casual conversations with the firm is also a smart idea.

The intangible aspects of a good partner are perhaps even more important than having capital and expertise. Will the firm preserve your company mission? Do you feel like your vision aligns with your new partner’s vision for the company? For many owners, what happens next with his or her company is important: will key employees stay involved, will current customers be taken care of, will facilities be upheld and reinvested in? The right partner is interested in keeping this vision intact.

1719 Partners is proud to focus on company owners’ visions and carry on the torch. For us, investing in companies is about more than generating positive investment returns—it is about making a positive impact. We are always open to having conversations. If you are interested in working with us, feel free to send us a message here.

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Finance, Industry Insights

How to Increase Customer Lifetime Value

Customer lifetime value is a powerful metric. In general, the higher your customer lifetime value and the more customers you have, the more revenue you can expect to make from your business. In turn, this can lead to increased profit. So, it is helpful to know how to increase customer lifetime value.

This post discusses the importance of customer lifetime value, how to calculate customer lifetime value, and, ultimately, how to increase customer lifetime value.

What is Customer Lifetime Value?

Customer lifetime value is the total amount of revenue a business expects to earn from a single average customer, over the entire business relationship. What makes this metric so powerful is that it is predictive: it estimates future revenue, which helps inform current business plans.

In this blog we use revenue, but profit is another way to consider customer lifetime value. Revenue is the total amount of money a customer or customers brings into the company, without considering expenses. Profit is the amount of money a company makes per customer or customers, when expenses are subtracted. When looking to increase customer lifetime profit, one can consider how to lower business expenses in addition to increasing customer retention. We do not go into that aspect of customer lifetime profit in this post.

How to Calculate Customer Lifetime Value

There are multiple formulas one can use for how to calculate customer lifetime value. They vary in complexity, with some models incorporating discounts, fluctuating costs, or customer trends. The more long-term customer data you have, the more detailed your calculation can be. A high-level equation to calculate customer lifetime value (CLV) is as follows:

CLV= Average Customer Revenue x Retention Period

In this simple equation, retention period stands for the total time period in which the average customer remains a customer. To obtain a more accurate, detailed customer revenue, you might create a predictive model. Such a model may predict the average customer to bring in $5,000 of revenue in year one, but perhaps this customer is commonly upsold to $10,000 revenue in year two. Historical customer data allows such complexities to be incorporated into the customer lifetime value formula.

The Importance of Customer Lifetime Value

When running a business, it can be easy to focus on acquiring new customers. While closing new deals is important for revenue, so is maintaining existing customers. In other words, if business A has less customers than business B but business A’s customer lifetime value is much higher, business A could make more revenue. At the same time, it is often easier to upsell current customers by expanding their selected products or services than it is to acquire new customers. A customer who already has a relationship with a company is more likely to buy more products or services than someone who would be a new customer. In an ideal world, a business focuses on both customer acquisition and retention.

So, a higher customer lifetime value can pay off exceptionally well for a business. The next logical question is, how to increase customer lifetime value?

How to Increase Customer Lifetime Value

Overall, there are two aspects to increasing customer lifetime value. The first principle is to not lose customers. This means employing strategies to increase retention. The second is to increase the revenue that each existing customer brings in– or increasing customers’ products and services.

While exact strategies to increase customer lifetime value vary by industry and company, below are some general guidelines to follow.

Create a Content Stream

In the digital age, creating content consistently no longer just sets you apart– it is required to maintain a strong business presence. A solid content pipeline increases company authority, causing current and future customers to trust you. A customer who trusts you is vastly more likely to expand services or, at the very least, not change loyalty to a different company. Consistently posting new content also keeps your company top of mind for current customers, increasing the likelihood of expanding products or services.

Creating content that stands up to the test of time also gives value to your customers between sales. When creating content, focus on holding attention by delivering high-value, educational tips and insights. When customers see the free value you deliver, they are likely to believe in your product and purchase your services. So, where to post this content? Depending on the industry, Instagram, LinkedIn, and blog posts are all viable platforms.

Email Marketing

Like creating a content stream, email marketing is a great way to remain top of mind for customers. Unlike publicly available content, emails carry a personal touch, as they arrive directly to customers’ inboxes. This gives you a chance to deepen customer relationships, expanding trust and brand loyalty. Company news, educational content, and stories are all great content pillars to focus on in emails.

Gather Customer Feedback

Running quick, easy surveys helps your customers remain engaged online while giving you direct insight into their preferences. For example, run polls on Instagram around which type of content they prefer, what they want to hear more of, or even which product they like best. Then implement this feedback into your offerings. For example, if they love a certain feature in your software, see if you can expand upon it or focus on promoting it.

Focus on Customer Service

Give customers as much support after they invest in your offerings as when trying to make the original sale. Could you expand your customer service team? Increase response time online? Inadequate customer service is a quick way to lose customers to a competitor. Today, users expect a fast online response time to any issues.

Improve Customer Lifetime Value: Business Growth

While these strategies are not always easy to implement, focusing on customer retention is essential to business growth. The more customers you have, the more stable your business is. In addition, happy customers are likely to spread the word about your business– giving you another customer acquisition stream.

Have questions about these strategies, or are wondering what makes the most sense for your business? We are happy to have a conversation. Simply reach out. 

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Industry Insights

The Ultimate Selling a Business Checklist: A Step-by-Step Guide for Owners

Selling a business can feel as overwhelming as it feels exciting. Once you have decided to sell, you likely have many questions: how to receive a business valuation, what documents to prepare, to use a broker or not, and more. This comprehensive guide turns “how to sell a business?” into a practical selling a business checklist. It complements other posts on due diligence, finding a family business exit strategy, and EBITDA.

Selling a business all starts with preparation. From preparing emotionally to sorting out financial and legal documentation, preparing the right way sets the groundwork for a successful exit. Post preparation, a business valuation readies you to enter negotiations with prospective buyers so you can sell your business for what it is worth. Finally, we touch on the due diligence process and how to successfully close the deal.

Selling a Business Checklist: 8 Essential Steps

Use this thorough selling a business checklist to ensure you are fully prepared before going to market.

  1. Are You Really Ready to Sell?

  • Have you clarified your reasons for selling?
  • Are you emotionally prepared to step away? Or do you want to remain with the business?
  • Is the business performing consistently?
  • Have you considered timing and market conditions?

Internal readiness is the first step to selling your business. Whether you are business exit planning to pursue a new venture, secure retirement, or pass on the business to a family member, fully understanding your rationale is the first step. Emotional readiness is the second piece. Many business owners are attached to the business they have been integral to for many years and letting go can feel hard.

Private equity recapitalization is one solution for business owners that want to obtain some liquidity and step away in some capacities but also wish to remain involved. In recapitalization, a business owner can have it both ways: sell part of the business, retain some ownership, and continue personal involvement.

There is also the external market to consider. Times of widespread economic decline would be a poor time to prepare a business for sale. It can be helpful to examine recent sales of companies in your industry to get an idea of if it is a fruitful time to sell.

  1. Obtain a Professional Business Valuation

  • Do you know your EBITDA?
  • Have you adjusted for owner-related expenses?
  • Have you benchmarked against comparable sales?
  • Have you used a valuation calculator or consulted an advisor?

Some business owners may wish to embark on this step in the selling a business checklist before step one. Getting an idea of what your business is worth can help you decide to either sell soon or hit pause and make some business improvements first. Understanding your company’s EBITDA is a core piece of understanding your business’s value: EBITDA multiplied by your company’s enterprise multiple yields a rough estimate of your business valuation. The enterprise multiple depends on many factors such as current market conditions, comparable sales, and the company’s growth potential.

Consulting a trustworthy advisor to obtain a business valuation is key. There are also business valuation calculators available online. Ours was developed through years of experience buying and selling businesses. Try it here. Knowing your valuation allows you to only entertain prospective buyers who are willing to pay market value, reducing your risk of selling for less than you could have.

  1. Organize Your Financial and Legal Documentation

  • 3+ years of financial statements
  • Tax returns
  • Accounts receivable/payable summaries
  • Fixed asset depreciation schedule
  • Customer contracts
  • Supplier agreements
  • Employment contracts and employee organization chart
  • Licenses and permits
  • Lease agreements
  • Appraisal or Valuation (if any)
  • Environmental studies (if any)
  • Corporate formation documents

This sounds like a lot, but it is important to have these documents ready for buyer scrutiny. You also may want to provide documents on your recent business successes, like positive customer reviews, as well as future marketing plans. This gives prospective buyers a snapshot of your growth potential, which directly impacts company valuation.

In addition, serious buyers will conduct due diligence later to examine your company’s operations in depth. During due diligence, the buyer may request many pages of documents to confirm your company’s historical performance, future performance estimates, intellectual property, and more. Getting a head start on this paperwork boosts buyer confidence and can accelerate the sales process.

  1. Clarify Your Exit Strategy

  • Are family members involved?
  • Have you considered tax implications?
  • Are you seeking a full exit or partial sale?

The answer to these questions directly impacts what kind of buyers you will entertain. For example, planning to sell to a family member looks very different from a buyer who wants to absorb your company and re-brand it. As mentioned above, options like a partial sale using recapitalization allow you to get the best of both worlds: stay involved with your company the way you want to and receive capital from a partial sale.

Selling to a family member offers many opportunities but also some complications to consider. Some family exit strategies work great in theory, but the family member who will carry on the torch lacks the finances to allow the previous owner to retire. 1719 Partners works with family-owned businesses to help the owner secure a family business exit strategy that works for everyone involved, so owners can sell without compromise.

  1. Prepare the Business for Sale

  • Resolve any outstanding legal issues
  • Clean and organize facilities
  • Repair or replace faulty equipment
  • Reduce owner dependency
  • Strengthen management team
  • Lock in key contracts if possible
  • Consider obtaining a sell-side QofE (quality of earnings report)

At this stage, final business preparations take place. The buyer will conduct due diligence before the deal closes, so it is important that the business looks good both on-site and in the paperwork. This means cleaning the premises and locking in contracts for the future if possible. For example, it is better to sign on a new customer now and potentially boost your company’s value than leaving a prospect unclosed.

  1. Decide How to Sell the Business

  • Does it make sense to use a broker or sell independently?
  • Have you evaluated your broker’s experience?
  • Does your broker of choice specialize in your industry?

Deciding to sell with a broker or not can be complicated. On one hand, qualified brokers offer industry expertise, an exclusive network of buyers, and the ability to handle complex negotiations. They also help market your business and help structure the deal. At the same time, using a broker is not free and the wrong broker may be more motivated to earn a fee than to find you the right buyer. Learn more about the pros and cons of using a business broker and how to sell a small business without a broker.

  1. Prepare for Due Diligence

  • Financial audit readiness
  • Data room preparation
  • Operational review

Due diligence is an essential step of the sales process. While it can be a headache, without due diligence, your business cannot be sold. We wrote this blog to de mystify the due diligence process.

  1. Successfully Close the Deal

  • Select a purchaser and negotiate a letter of intent
  • Complete due diligence
  • Negotiate purchase agreement and all ancillary legal agreements
  • Purchaser secures required financing
  • Plan employee and customer communication and retention
  • Close the transaction and execute transition plan

While the six bullet points above sound easy, in reality, closing a transaction is an arduous process that takes approximately 90 days of full-time attention.

Common Mistakes to Avoid When Selling a Business

Following this guide will help avoid common pitfalls of selling your business. When sellers delay preparation, do not gather the necessary due diligence documents, or hide issues from buyers, problems arise. Being fully transparent with buyers from the start helps build trust and minimize transaction issues down the road.

Selling a Business is a Process

Selling a business is not one event, but rather a series of interconnected steps. Reference this guide as you tackle preparations and navigate each stage of the process. If you have any questions on preparation or are curious about the value of your business, contact us. We are always happy to have these conversations. Or use our free business valuation calculator to kickstart the process.

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Finance, Industry Insights

What is a Finder’s Fee?

What is a finder’s fee? When used correctly, finder’s fees benefit all parties involved. Often, without an intermediary earning a finder’s fee, a transaction between two parties would not occur. This post explains what a finder’s fee is, how it works, and includes a finder’s fee agreement sample.

Finder’s Fee Meaning

A finder’s fee, also known as a “referral fee” is a way for one party to compensate another for a referral. The earner of the fee, or “finder,” typically provides an introduction of two parties (often a buyer and a seller) who did not previously know each other. Because the introduction is potentially valuable to at least one party, one or both of the parties are willing to pay a fee for the introduction. Hence the term Finder’s Fee.

Most finders’ fees are contingent upon some event or transaction actually occurring. In other words, the finder is not compensated until/unless the parties find the introduction valuable and complete a transaction. Upon the official transaction, the finder earns the fee.

Finder’s Fee Agreement

While it is possible that a finder could have a verbal arrangement with another party, they are usually documented in a written contract. For example, if you have a friend who would like to sell his mint condition 1972 Chevrolet Corvette, he might agree to give you a $5,000 finders fee if you bring him a qualified buyer and the transaction closes. A transaction like this might be a handshake agreement and there is no need for a written contract. On the other hand, if your neighbor wants to sell his $100 million company, and you know a potential buyer, finalizing the terms of your engagement in a written contract is an important step in the process.

Who Pays the Finders Fee? The Buyer or the Seller?

Either one! The Finder typically enters into a contract (“Finders Fee Agreement”) with either the buyer or the seller. In rare cases, the Finder might enter into a contract with both the buyer and the seller.

What Is Included in A finder’s Fee Contract?

Please see the sample Finder’s Fee agreement at the end of this post. A finder’s fee contract includes key provisions including but not limited to:

            Names of all parties involved

            Length of the contract

            What services are being provided and what has to occur for the fee to be earned

            Confidentiality and non-circumvention

            How is the fee calculated and paid

How are Finders Fees Calculated

Finders Fees are negotiated between the parties in the agreement. The fee is generally aligned with the value of the introduction and the value of the transaction. When selling a business, the Finder’s Fee is frequently based on the Lehman Formula. See the example below for a Fee Agreement that utilizes the Lehman Formula.

Does Private Equity Pay Finders Fees

Yes! Private equity firms regularly enter into buyer paid fee agreements that are are paid upon a successful transaction closing.

Finder’s Fee Agreement Sample

Note: This is an example of a Finder’s Fee, and it is not intended for your use. 1719 Partners is not providing legal advice. This sample agreement uses a Lehman formula.

This Fee Agreement (“Agreement”), dated as of [insert date here], sets forth the terms and conditions upon which [insert finder name or legal entity here] (“Finder”) shall act as non-exclusive finder for [insert buyer or client name here](“Client”) and/or its assigns for two (2) years from the date hereof (“Term”).  In such capacity, Finder shall introduce representatives of the Client to the owners and senior executive officers of [insert target company name here] (“Target”)and shall obtain and provide information regarding the business affairs and prospects of Target, including detailed financial statements and any other information reasonably requested by the Client, in connection with any due diligence investigation Client may undertake (the “Services”).

Client hereby engages and agrees to cause Finder to be compensated if Finder’s introduction to Target during the Term results in Client purchasing 25% or more of the capital stock of Target, or all or substantially all of the assets of such candidate, within 24 months of the date Finder introduced such qualified investment candidate to Client (a “Transaction”).

In consideration of Finder’s provision of the Services, if a Transaction is consummated, a finder’s fee (the “Fee”) shall be paid, or caused to be paid, by Client to Finder on the day of the closing of the Transaction, such Fee to be based on the Purchase Price (as defined below) paid by Client in connection with the Transaction. Such fee shall be computed as follows:

5% of the first $1,000,000 of the Purchase Price, plus

4% of the next $1,000,000 of the Purchase Price, plus

3% of the next $1,000,000 of the Purchase Price, plus

2% of the next $1,000,000 of the Purchase Price, plus

1% of the balance of the Purchase Price.

The “Purchase Price” is defined as the aggregate consideration (whether in the form of cash, assumed debt or other non-contingent or non-deferred contribution of value) paid by Client to acquire its equity, debt or other interest in Target. In the event that any portion of the consideration paid by Client to acquire its equity, debt or other interest in Target is contingent or deferred, such consideration will be included in the Purchase Price.

For purposes of this Agreement, the term “qualified investment” shall mean an investment (i) in which Client or its affiliates obtains control of a corporation, limited liability company, partnership or other entity over which it did not have previously have control; and (ii) with respect to which Client has made no contacts with any parties related to such investment, has taken no steps to consider or pursue, has not learned of through any source other than Finder, and about which Client has no information. For purposes hereof, “control” of an entity shall mean the ownership of more than 25% of the equity securities of such entity, or the power to direct or cause the direction of the management and policies of such entity. In the event that Finder discloses to Client the name and address of Target that Client determines is not a qualified investment candidate, or if Client is already aware of Target, Client shall so notify Finder within five (5) business days of such introduction.

During the Term, the relation between Finder and Client is that of unaffiliated third parties. Finder and its officers, directors, employees and agents shall, under no circumstances, be deemed agents, employees, partners or representatives of Client.

Each party shall bear its own costs and expenses incurred in connection with the undertakings contemplated by this Agreement.

This Agreement shall be construed under the laws in the State of [insert state here].

This Agreement may be signed in counterparts, each of which shall be an original, but all of which together shall constitute one agreement.

IN WITNESS WHEREOF, the undersigned have executed this agreement on the day and year first above written.

Client:                                                                    Finder:

What is a Finder’s Fee: In Short

In summary, a finder’s fee is a way to reward an intermediary for linking together two parties who otherwise likely would not have met. It incentivizes the “finder” to forge rewarding connections, as the finder is not compensated until the deal closes. If you have any questions on how finder’s fees work in private equity, 1719 Partners is happy to answer them. Simply contact us here.

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Finance, Industry Insights

Financial Reporting in Due Diligence

Most business owners have a good grasp on their internal financial statements and ask their outside accountant to prepare the company tax returns. As a result, most business owners are less familiar with the nuances of their tax return, and may not be aware that the information in the tax return might be different than their internal financial statements.

A business owner recently asked me, “Why do you need to meet with my accountant and review the tax returns?” It’s a good question. Why review both the financial statements and the tax returns? Isn’t this a duplication of effort? 

The answer is that the reconciliation between the two is a material aspect of due diligence. Tax returns are often more reliable than internal financial statements. They are prepared with an eye towards being audited by the IRS instead of just for internal use. The exercise sometimes brings to light useful information.

In addition, tax regulations and accounting regulations often differ on certain aspects. For example, the tax return may use accelerated depreciation whereas the financial statements may use a straight line depreciation method. This will create a book/tax difference. Also, many business owners are not accounting experts and might not fully understand the differences between the two statements.

 

I’ll give you a recent example:

During negotiations, the owner of a business said his salary was $150,000 and that he wanted to continue that going forward as an employee of Newco. This made sense to us and we agreed. We entered into a letter of intent based upon the company’s income statements which we assumed included the $150,000 salary. But what we learned after reviewing the tax returns was that the owner’s $150,000 salary was in fact a distribution and as a result, the $150,000 cost was not included in the income statements. So our understanding of the cash flow of this business was overstated by $150,000. Said another way, the $150,000 salary lowers EBITDA by $150,000. Using a 5X multiple, this equates to $750,000 of enterprise value. Not a small number. The owner wasn’t intentionally trying to mislead us, but without digging in and comparing the income statements to the tax returns this may have slipped through.

 

1719 Partners is an experienced buyer and understands the importance of thorough due diligence. If you are interested in selling your business and want to better understand the diligence process, or if you are a management team seeking to purchase a business, please contact us. We would be happy to share our thoughts with you.

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Finance, Industry Insights

What Is an Earnout in M&A?

If you are considering selling your company, it is important to know an earnout is an option. An earnout can be the bridge between your asking price and what the buyer is willing to pay, allowing you both to accomplish your goals. Understanding how an earnout works allows you, as the seller, to consider all your options. 

This guide explains what an earnout is, when it is used, how it is structured, and common pitfalls. 

What Is an Earnout?

An earnout allows both buyer and seller to settle on a purchase price. In short, an earnout divides up the total purchase price into an immediate payment and a deferred payment. For example, if the seller believes his company to be worth $120 million and the buyer thinks its value is $90 million, an earnout can cover the difference. In this case, the buyer would pay $90 million upfront and structure an earnout for the remaining $30 million. 

An earnout is also contingent upon the performance of the newly purchased company. In other words, there are strings attached. This motivates the seller to increase company performance post acquisition, which reduces the risk on the buyer. Company performance is objectively measured by key metrics that both parties determine beforehand. For example, these metrics can look like meeting a certain revenue or EBITDA margin, or retaining key customers. 

Earnouts in M&A: When Are They Used?

There are many situations where using an earnout makes sense. For example, perhaps the seller has just acquired a big customer or launched a marketing campaign, and expects the business to exceed past performance. The seller believes the purchase price should reflect this advantage, while the buyer is skeptical. After all, from the buyer’s perspective, his or her concerns are valid: what if the big customer falls through, or the marketing initiative fails? 

With an earnout, the seller receives down-the-road payments when the business does, in fact, meet expected performance goals. If the business does not, then the buyer does not have to make the corresponding payment to the seller. Below are some specific situations where an earnout makes sense. 

Bridge a Valuation Gap

If the buyer and seller want to work together but do not see eye to eye on the purchase price, an earnout allows them to move past this hurdle. Another common way to bridge a valuation gap is using a seller note. However, a seller note is not contingent on company performance. While a seller note is nice because it gives the seller guaranteed later payouts, it does not allow the payments to increase based on company performance. Effectively, the payment cap is lower. This may be undesirable if the seller believes his or her company will perform highly in the near future. 

Improve Ownership Transition

Passing the baton is not without risk. To reduce risk of company harm during the ownership transition, the buyer may want to include an earnout. This works because a later earnout payment motivates the seller to set up the company for continued success. In other words, the seller is financially motivated to see the company continue to perform, rather than simply wanting to “get paid and get out.” When the buyer and seller’s interests are aligned in this way, the company has more support to succeed. 

Sell to the Right Buyer

Sellers often want to hand the business off to someone who will continue the business legacy. If the seller finds a buyer with a shared vision for the company, but the parties do not agree on purchase price, this can be disappointing. An earnout allows the seller to “have their cake and eat it too”— not having to sacrifice either purchase price or the ideal buyer. 

If you are struggling to find a buyer who sees eye to eye on your business legacy and also has the capital to help you reach your goals, check out 1719 Partners. Our legacy is supporting your legacy. 

Sell at the Right Time

There are many reasons why it may be the right time for the owner to sell. Maybe he or she is facing health obstacles or burnout, or it is time for retirement. Without an earnout, the seller would have to decide between selling immediately, and receiving a lower purchase price, or waiting a few years until the purchase price can reflect company growth. In fast-growing or newer companies, this issue is extra relevant. An earnout allows the seller to sell at the right time without sacrificing on future business gains. 

Earnout Structures

There are many ways to structure an earnout. Earnouts should have a defined term, typically lasting one to three years. In addition to the term, performance metrics are also clearly defined. This reduces confusion between the buyer and seller. For example, the chosen metrics may be related to revenue, EBITDA, or customer retention. 

Earnouts are also structured through percentages. For example, an earnout might be a percentage of revenue, revenue associated with key customers, or profits or EBITDA. 

Earnout Calculation Examples

Exact earnout payouts are calculated based on the terms. In addition to the percentages mentioned above, earnouts have more detailed terms as well. These specific details limit the earnout’s maximum payments. For example, an earnout might have a lifetime cap of $1 million. This means throughout the earnout’s entire term the payments cannot exceed $1 million. Another structure might be 10% of revenue annually if the agreed-upon metrics are met that year, as well as a yearly maximum payout of $500,000, and a lifetime maximum of $1.5 million. This earnout may also end in four years. In addition, if metrics are not met one year, that year’s payment could be $0. 

Common Pitfalls

As with any legal agreement, there are potential problems. In general, pitfalls are caused by nonspecific terms. Vague terms can look like an open-ended time horizon, no annual or lifetime payment caps, and more. 

Typically, earnouts include a dispute resolution section. This provides instructions for handling disagreements, such as deferring to a third-party accountant or auditor.

Considering an Earnout? 

Are you wondering if an earnout makes sense for you and your company? 1719 Partners has helped structure many successful transactions. We have seen earnouts play a crucial role in meeting both the buyer and seller’s goals. We understand that selling a business is a very personal process and situations can vary widely. 

If you are considering a sale or have general questions about earnouts, don’t hesitate to reach out. 

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Industry Insights

Family Business Exit Strategy: Tips to Make the Right Choice

Developing a family business exit strategy is more than just a financial decision. Your strategy not only secures your financial future, but it also determines loved ones’ livelihoods. This personal and often complicated decision deserves thoughtful consideration. 

In this post we cover everything you need to know about developing your family business exit strategy, from timing to choosing the right action plan. While no two situations are identical, this guide will help you make an informed choice.

Why a Family Business Exit Strategy Matters

As a family business owner, you know firsthand how much your company means to you and those around you. Your business has brought opportunities to your family and employees, positive experiences to your customers, and a sense of purpose to your work. As much as securing your financial future is important, so is preserving your company legacy and protecting the careers of those you care about. That is why this post is so important— with the right exit strategy, you do not have to sacrifice your company vision for financial security.

Is Now the Right Time?

Eventually, it comes time for every business owner to pass on the torch. These reasons can vary from retirement planning, to navigating illness, to changes in family dynamics, or even simply wanting a career change. Whatever the exact reason, deciding it is time to move on is the first step. If you are unsure, it is important to reflect and ask yourself, should I sell my business?

The second piece is how to receive the most value from a business sale. It is often helpful to conduct a business valuation to get a rough idea of what your company could be worth, and then make decisions accordingly. For example, if your business valuation reveals a company sale could be especially lucrative, you may consider selling soon. On the other hand, if a valuation suggests areas to improve your business worth, waiting may make sense— if possible. 

Should Family Carry On the Torch?

For owners of a family business, the important question is: is my child fit to run the business? The answer to this question helps determine what the best family business exit strategy is. It can be hard to set emotions aside and answer this question logically, especially when your company and your children mean so much to you. However, answering this question honestly is essential for your business’s continued success. 

There are really two pieces to this question. The first is, does your child want to run the business? If your potential successor has no desire to step up to the plate, then his or her capability is irrelevant. If the family member in question does want to run the business, then you must consider if he or she is capable. Answering that question can be difficult, and it is important to keep in mind that even the right successor will likely need mentorship. 

For this reason, it helps to develop a family business exit strategy a year or two before the transition. This gives the new leader time to learn the ropes and prepare to step into his or her new role. That way, you will feel confident when it comes time to pass the baton.

Choosing the Right Family Business Exit Strategy

There are a variety of options to consider. Making the right choice for your business’s health as well as your financial security can be complicated. Finding the perfect family business exit strategy can prove even more challenging when you need liquidation to retire while wanting a family member to continue your legacy. 

To help you explore your options, we list possibilities below— so you have all the information, whether you plan on a family member taking over or not.

Management Buyout

A management buyout is, like it sounds, when existing management purchases the company from the previous owner. This can be a good option when there is no family successor to inherit the business. 

A management buyout allows you to personally select a buyer or buyers you know, giving you confidence that your company will be in good hands. It also makes for a smoother transition, as the new owners are already familiar with the company. At the same time, you gain the financing needed for retirement or the next phase of life. 

Unfortunately, the purchase price in a management buyout may be less than the owner would have received in a competitive auction. However, this downside may be worth it for the assurance that the company will be “run as before.”

Sell to the Family Successor

This option would accomplish the previous owners’ goals: secure retirement funds and allow the next generation leader to own the business. However, there are some issues. 

Selling the company to a loved one may put financial strain on the new owner, which creates a conflict of interest when working with family. If this route is selected, the new owner will likely need to repay his or her parents through issuing a seller note rather than a lump sum, which is not ideal for the sellers.

Gift the Company

Giving the business to the next generation owner is one possibility. However, this is often not an option for the previous owners as they need financing for the next stage of life.

Sell to a Competitor

This option may be lucrative, but can prove problematic if you would like family members to remain employed. While you may be able to retire or move onto the next phase of life with higher earnings, there is no telling what business changes the new owner might make. They easily could decide to fire important family members, and make other widespread employee changes. Indeed, your business legacy is at risk here as well as family members’ careers.

Sell Without Compromise— Meet 1719 Partners

As the options above demonstrate, it is difficult to hand the reins to the next generation family member while securing retirement.

There is one way to tick all the boxes: selling to an investor who has your best interests at heart. When you sell to 1719 Partners, you gain a partner who is dedicated to continuing your company legacy. This means supporting the next generation family member as he or she runs the company. Our approach is to build off of the foundation you created— that means not firing employees, consolidating operations, or changing your company name. 

With us as your partner, you receive the necessary financing to retire, while your preferred successor locks in the leadership role. Periods of transition are our expertise: we have helped dozens of companies turn transitions into success stories. 

Interested in partnering with us? We would love to connect, simply contact us.

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Finance, Industry Insights

Letter of Intent to Buy a Business: Protect Your Transaction

Entering into a letter of intent to buy a business is typically the first formal step in the process of buying or selling a company. Understanding a letter of intent, how it works, and what it includes is especially important if you are a first-time buyer or seller. This post will discuss several aspects of a letter of intent to buy a business, including why an LOI is helpful, key components of a letter of intent, and a few common pitfalls. 

What Is a Letter of Intent?

A letter of intent to buy a business (“LOI”) is a legal document that buyers and sellers commonly voluntarily execute when they reach an agreement to purchase/sell a company.  An executed letter of intent to purchase a business does not mean the transaction has “closed” but rather that the transaction process is “starting” and heading toward a closing.   

In other words, the LOI serves as the bridge between a handshake-level interest and a definitive purchase agreement. For many first-time sellers, this is the moment when casual conversations turn into a formal process.  

Why Is a Letter of Intent to Buy a Business Helpful?

A well-crafted LOI is a roadmap for all participants to get from “let’s do this” to a closing.  The due diligence process and legal documentation can be stressful, especially for participants who are unfamiliar with them.  The letter of intent helps outline the diligence process, key legal terms, transaction details, and other important components to ensure that all parties are on the same page and to minimize surprises.   

A letter of intent to purchase a business does not need to be a 15-page mini purchase agreement, but at the same time, the LOI is unlikely clearly define the transaction if it is only a page or two and is silent on important topics.  An appropriately drafted letter of intent is typically around four or five pages. 

Think of it as a roadmap: the clearer and more specific it is, the easier the journey will be for both buyer and seller. 

What Are the Key Components of a Letter of Intent to Buy a Business?

Confidentiality

Business owners are often very concerned about confidentiality and the reaction of customers and employees. LOIs usually reference that the terms of the transaction and the discussions themselves are confidential. There is also usually a several–year tail on the confidentiality period.

Exclusivity

Buyers will have to expend significant resources on conducting due diligence, preparing legal documents, and so on. As such, buyers commonly require exclusivity to invest this time, effort, and money in a transaction.   Exclusivity typically means that the seller, once they have signed a letter of intent to sell their business, will not entertain offers or speak to other potential suitors while the existing letter of intent is in place.  Exclusivity typically lasts between 90 and 120 days. 

Timeline

The LOI typically includes a schedule outlining the timeline between the execution of the LOI and closing, as well as a timetable for achieving major milestones or hurdles, such as securing debt financing. 

Transaction Terms

The LOI contains all key transaction details and financial terms, including but not limited to: 

  • Valuation and Structure
  • Asset vs. Stock Purchase
  • Real Estate
  • Key Employee Agreements
  • Non-Compete Terms
  • Escrow
  • Any Excluded Assets
  • Etc.

The letter of intent might also address other topics, such as representations and warranties, indemnification limits, and the indemnification period. While these topics will be negotiated and finalized in the actual asset purchase agreement or stock purchase agreement, it is helpful to have some consensus on major deal points in the letter of intent. This is so that the legal documentation process goes more smoothly. 

Binding Vs. Non-Binding Letters of Intent to Purchase a Business

Most LOIs to purchase a business have some provisions that are binding and others that are not. For example, exclusivity and confidentiality are typically binding, meaning that both parties are obligated to fulfill these commitments. Other provisions – such as the target closing date – are usually non-binding. 

Fees and Expenses

Most LOIs include a discussion of which parties are responsible for paying transaction fees and expenses. This is particularly relevant in cases where a transaction fails to close for any reason. It is most common for buyers and sellers to each pay their own expenses; however, there are situations where certain parties may agree to cover specific aspects of the deal costs. For example, perhaps the buyer will pay the investment banking fees earned at closing. 

Who Signs a Letter of Intent to Purchase a Business?

Both the buyer and the seller, as legal entities, execute the letter of intent to purchase a business. In many cases, especially with smaller private companies, the shareholders of the selling business may also sign as individuals. This is because they may agree to specific key provisions – such as a non-compete agreement – on an individual, personal basis. 

What Are Common Pitfalls in a Letter of Intent?

Open-Ended Exclusivity

A LOI must have a termination date that expires at whichever comes earlier: (a) the transaction closing, or (b) a specified date.  Failure to include a termination provision can result in a seller being locked in indefinitely. 

Vague Key Terms

Key transaction details, such as valuation, the amortization schedule on a seller’s note, or how the earnout is defined and calculated, need to be clearly described and defined in the letter of intent.  A letter of intent to buy a business that includes a provision stating “final purchase price will be determined at closing” is problematic. 

Summary

A letter of intent to buy a business is a detailed roadmap that ensures all parties are on the same page as they head toward successful due diligence, legal documentation, and closing. It creates structure and trust, while minimizing surprises that could derail a transaction. 

At 1719 Partners, we’ve helped business owners navigate this process many times. Whether you are preparing to sell your company or evaluating a potential acquisition, the right LOI sets the tone for the deal. 

Thinking About Buying or Selling a Business?

A well-written letter of intent protects your interests and drives your transaction toward a successful close. At 1719 Partners, we have ample experience structuring letters of intent— if you have questions or would like advice on yours, feel free to contact us.

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Industry Insights

Underestimated Industries: The Tortoise Beats the Hare

If you ask someone how to become a successful entrepreneur, chances are they will mention Silicon Valley. After all, those are the stories that make headlines. In the fast-paced world of tech startups, success happens quickly— and what sounds more exciting than growing by 50% year after year? It is no wonder other paths to success remain hidden in the shadows. But in reality, Silicon Valley makes up only a small portion of wealthy entrepreneurs…so what about the rest of them?

There are opportunities hiding in every corner of the world. There are businesses all around us for the goods and services we take for granted. The Wall Street Journal article “Meet the ‘Stealthy Wealthy’ Who Make Their Money the Boring Way” mentions an owner who built an entire business on elementary school carpeting. There is an industry out there for schools that need their carpeting redone almost every year— as making messes is something young children are talented at. In 2022, that business owner made over half a million dollars (excluding capital gains).

The article mentions another business owner who found success through car floor mats. Upon realizing floor mats abroad were much higher quality than those in the U.S., he began importing and selling the English-manufactured mats locally. As the business grew, he added to the product line and manufactured more and more goods in the U.S. This year, he predicts around $800 million in business revenue.

Making money in ways like these is more common than you would think. 1719 Partners has worked with business owners in industries like metal fabrication, value-added distribution, and flexographic printing. In the flexographic printing industry, we helped Custom Label transition ownership to a talented management team, and then worked together to create significant wealth. Indeed, we built this success the “boring” way: with a compound annual revenue growth rate (CAGR) of around 12%, a far cry from the exciting 50% some tech startups boast. However, after 20 years of ownership, the long-term growth has been notable.

As this story demonstrates, slow and steady often wins the race. While tech companies can hit the ground running, they can also become outdated just as fast. Short of elementary schools becoming 100% remote (doubtful), school carpeting will always be a need— as will car floor mats. Regardless of what new technology is emerging in Silicon Valley, the need for certain “boring” goods and services never changes.

Indeed, if you invest in companies that will always be a staple to society, growth is virtually unlimited. While the growth may happen at a slower rate than a Silicon Valley startup in its infancy, it may well outlast the flash in the pan. Long-term growth also enables returns to compound. When comparing closed-end fund structures of a typical private equity firm with long-term holds, we found that longer investments far outperform the shorter ones. Click here to see how much.

With all this in mind, more entrepreneurship dreams should focus on industries like manufacturing or value-added business services. If you and your management team are ready to step into ownership and just need a partner, reach out. 1719 Partners is as passionate about business ownership as you are.

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Finance, Industry Insights

How Much do Brokers Charge to Sell a Business?

Selling your business is one of the most important financial decisions you’ll make. While many owners turn to business brokers for support, before hiring a broker, it is important to understand how brokers work, and how much brokers charge to sell a business. (For a broader look at whether using a broker is right for you, check out our guide to selling a small business.) 

What is a Business Broker? 

A business broker is a professional intermediary who assists business owners in selling their businesses. They evaluate your business, provide guidance on a selling price, confidentially market the business, and vet prospective buyers. Typically, a business broker helps small and lower-middle market business owners, particularly those with limited time or transactional experience. 

The goal of a business broker is to get a deal done, often by packaging the business attractively and creating a competitive bidding process. Not all brokers are created equal, and their value must be weighed against the cost. 

How is a Business Broker different from an Investment Banker? 

Business brokers and investment bankers both provide advisory and consulting services helping business owners navigate the sale process. While largely semantics, most people would say that investment bankers tend to focus on larger enterprise transactions (i.e. enterprise value in excess of $50 million) while business brokers tend to focus on smaller transactions. 

How Much Do Brokers Charge to Sell a Business? 

So, how much do brokers charge to sell a business? Business brokers (and investment bankers) typically enter into a formal contract, or engagement letter, with their clients that details a number of factors including compensation. These engagements and compensation structures can vary significantly depending on the scope of the project. For a very limited scope of work, for example preparing an offering memorandum or a valuation, the engagement might be a flat fee. If the service provider is an accountant or an attorney, they might prefer to charge by the hour. Most brokers prefer a success fee arrangement.

Business Broker Fees 

Business broker fees can vary significantly depending on the size, type, and complexity of the business sale. Typically, brokers charge a commission, or “success fee,” usually structured as a percentage of the final sale price. 

  • Success Fee: Most brokers charge a success fee between 5% and 15% of the final sale price for small businesses. For larger transactions, brokers often use the Double Lehman Formula or Modern Lehman Scale, which tiers fees by price range.  The table below shows a standard (not double) Lehman success fee calculation. 

      Lehman Commission Structure: example showing $12,500,000 sale price

Table demonstrating how much brokers charge to sell a business, based on the Lehman fee structure

  • Retainer or Upfront Fee: Some brokers charge an initial fee ($5,000 to $50,000+) to start the engagement. This covers preparation, marketing, and administrative costs. 
  • Minimum Fee: Even for smaller deals, brokers might require a minimum fee, usually between $25,000 and $50,000, regardless of the sale price.

What Is the Business Broker Commission?

The business broker commission rate is a negotiated rate, and the rate often depends on both the anticipated transaction proceeds, and a successful sale process. If the total proceeds in a successful business sale are less than $1,000,000, the business broker commission could be 10%— or more— of the total sale price. For larger companies, the business broker commission often follows a tiered Lehman Commission Structure. Please see the section above for more detail on the Lehman Structure.

Who Pays the Business Broker Fee? 

The seller almost always pays the business broker’s fee, which is usually deducted directly from the sale proceeds at closing. From the buyer’s perspective, there’s no fee, but buyers know that brokered deals might involve more competitive tension and potentially higher prices because of the structured process. Also, it’s a little like “free shipping”.  There is no such thing as free shipping – its cost is just baked into the price. 

Can You Negotiate Business Broker Fees? 

Yes. Broker fees can often be negotiated, especially the upfront retainer. If your business is highly marketable, you can negotiate a lower percentage or a more favorable tiered structure. Just remember: in many cases, you get what you pay for. A good broker should earn their fee through a higher purchase price or a smoother process. 

How Do I Find Business Brokers Near Me?

A quick Google search can help discover business brokers near you. Why may a business broker near me be preferred over a non-local one? Local business brokers have expertise that may help find the perfect local buyer and a higher closing price. And for a buyer that is not local, a local business broker is able to explain to a non-local buyer what makes your area so marketable, ultimately making your business more appealing.

Alternatives to Using a Business Broker: How Else Can You Find the Right Buyer?

Not all businesses need a broker to find the right buyer. If you have a strong network, a desirable business model, or interest from strategic acquirers, you can sell your business without hiring a broker. If you want to sell your business on your own, here are a few tips to help you gain exposure: 

  • Leverage your personal and industry connections. 
  • Quietly test interest with suppliers, customers, or even competitors. 
  • List the business confidentially on curated M&A platforms. 
  • Reach out directly to investment firms or buyer groups aligned with your industry. 

What to Do if a Buyer Reaches Out to You?  Should You Hire a Broker at This Point?  

Hiring a sell-side advisor in response to an unsolicited offer could facilitate a smooth exit, or it could just muddy the waters, with the pain of paying additional fees. If you like the buyer and if you have a good grasp on your company value, hiring a broker at this point in the process is probably not beneficial.  If you have no experience in mergers and acquisitions, and are not comfortable managing the sale process without outside guidance, hiring a professional to help could be beneficial.

For more on the pros and cons of hiring a business broker, check out this blog. 

The Buyer You Didn’t Know Existed: The Private Investor Who Has Your Best Interests at Heart 

Private equity buyers like 1719 Partners often fly under the radar but offer an attractive alternative to traditional brokers or strategic buyers. We partner with owners of specialized manufacturing, value-added distribution, and industrial services businesses. What makes us different? 

  • We have the capital and experience of private equity, without the sharp elbows. 
  • We prioritize legacy, employees, and long-term success, not quick flips. 
  • We can work directly with owners, streamlining the deal process and eliminating the need for a broker. 

Let’s Talk  

Interested in seeing if we’re the right fit for you and your business? Want to explore how 1719 Partners can help you accomplish your personal and business goals? We’d be happy to have a conversation. Send us a message.

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