What is it? It is a deal structure where the seller retains an ownership stake in the business after sale.
Why is it popular? While it’s pitched as “upside” investors use this as a way to reduce risk!
Risk of capital – by putting in less capital upfront, risk of operations – if the investors team is not as good operating the business after acquisition and the risk of market changes – especially true if the bulk of the income is from one source e.g. Amazon
Is it right for you? Get clear on three things, BEFORE selling
1/ Goals – what are YOUR goals for selling your business?
2/ Control – who is in control of the business after you sell? Can you control the outcome?
3/ Track record/background of the INVESTOR/S and their team. You want to make sure they’ve had success doing this before!
Podcast: Download (Duration 7:58 – 12.9MB)
Hey everyone, it’s Coran. The founder of the FBA Broker and your friend on Facebook. I wanted to talk about something that has been quite popular right now. Since we made the change to working and having a minimum list price of 1 million dollars on businesses that we take to market we’ve seen interesting trends with deal structures. I wanted to talk about this because it’s quite popular in the seven and eight-figure deal range and we’re going through a couple of these right now. I was literally writing this out as a framework for a client and I thought this would be a great concept to share with everyone else. What are we going to talk about right now is Deal Making 101 and this is what I’m calling this future series. Today I’m going to talk to you about Equity Rollover. I’m going to explain what it is, why it’s so popular and how you should think about it. If you are the seller in this case looking to sell your business and how you should think about equity rollover.
What is Equity Rollover?
Basically, it’s a deal structure where the seller if you’re the seller retains an equity percentage of the company ownership stake in the business after the sale.
Why is Equity Rollover so popular?
Well, an investor or investors will often pitch this as an upside for you saying look at all the opportunity that’s available with your business. They’ll pitch this as upside for you and there may be upside and there hopefully is upside in the deal. But why a buyer makes this offer is to reduce their own risk. So it’s important to understand why this mechanism is being used.
Risk of Capital
A couple of things they could reduce is the risk of capital. They don’t need to put in as much cash upfront say it’s a $10,000,000 deal and they make an offer of you retaining say 50 percent of the business and they need to put in $5,000,000 to control a $10,000,000 asset.
Risk of Operations
That’s one example, the other could be operations. If they think there are operations risk operating the business moving forward. Say the business generates the majority of its revenue on Amazon, which a lot of our clients do the investor may not have a ton of experience selling via Amazon. There’s an operational risk that maybe the team can’t take over and run the business as well as you have up to this point.
Next is the market changes themselves. There is a risk of the market moving, the trend, the niche you’re in maybe there is excess competition down the line. Maybe something changes with Amazon or Google wherever your main revenue channel has come from. It allows the buyer to acquire or the investor that acquired your business for less money to mitigate some of the risks and share some of that upside.
There is a scale of cash versus equity that a buyer is using and it’s almost the flip side for most sellers. How this works is I call it the zero to 100 game. I was talking to some investors last night. They are value investors and this means they want to acquire distressed assets. They get these deals when something is wrong with the business they get a very good price and then have almost infinite upside. And for them ideally, they’d like to get the assets for nothing, which makes sense. If you can control a cash flowing asset and take control with that cash flow without outlaying money that makes sense. On the sell side do you want to get as much cash up front as you can? You take the cash off the table right now. So there’s future cash versus today and this is really what they’re talking about.
An investor, really everyone is less attached to future money than they are to current money. In private equity circles, they call this the second bite of the apple. You sell a piece of your business today, you continue working with the business hopefully it grows and then you get a higher exit value or a second cash out at the next sale.
Is this right for you?
There are still three things to think about for yourself if you are the seller in one of these scenarios and this is the deal that you’re being offered.
What are your goals in selling your business? And this applies to any business not just the eCommerce product based Amazon businesses. Why are you selling? Sometimes there’s a reason that you wanted to get out of the business and you’d want a certain amount of money. Make sure that those goals are taken care of as part of the deal. Also, what you want to do next. Would you like to keep running the business and grow the business but get a capital partner on board so you have less cash risk tied up or personal risk tied up in the business?
How much control do you have over the situation moving forward? If you’re a minority or a majority stakeholder in the business after the sale who’s going to run the business? If you completely hand over the reins of your business and you’ve only taken say 50 percent of the cash off the table but you don’t have operational control or strategic control that’s something to consider and think about. If you hand over the reins and then they screw up the business there’s no equity left, that percentage now isn’t worth anything.
3. Track records
The third thing that kind of goes in with control is to look and dig into the track record of the acquirer. Talk to the investors, your broker should help you with this and understand their motivations, their background and their plans moving forward. Right now there’s a few different options or different goals that investors have in the seven and eight figure deal range that we’re dealing with right now. Some of them want more permanent capital, so maybe they’re a family office that’s self-funded. They’re looking long-term, working with an investor that’s looking long-term. This may be a great fit for you if you think there’s a long runway for the business and you don’t need a lot of cash today. You’d want that cash flow stream into the future. If you’re retaining 20, 30, 50 percent of the business moving forward that could be a great option for you if you don’t have a timeline.
Others, if they’re a traditional private equity firm they will typically have a five to seven-year period they must sell the asset within. Depending on where they are in the lifecycle they may be a year or three years away or seven years away from having to exit. This could also factor into how long you need to stay with the business moving forward.
That is a couple of thoughts that may be useful to think about when considering if this is the type of deal structure for you when you get to the stage of selling.
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