How do consulting agreements work when selling a business?
How do consulting agreements work in selling a business?
I get this question a lot in M&A.
The purchase price of a business can have a number elements:
1. down payment (cash equity from the buyer)
2. bank financing
3. seller’s note
4. installment sale
5. earn-out
6. commissions on future sales
7. consulting agreement for the seller, post-acquisition
Earn-out’s, commissions and consulting agreements are often used to “bridge the value gap” between buyer and seller.
In some cases, an earn-out is prohibited (SBA loans usually do so), or impractical. So, a consulting agreement can help.
Let’s say you own a business and the buyer offer’s $1 million, but you think the business is worth $1.2 million based on growth potential with a new customer coming in. The buyer thinks there is downside risk that customers may leave, once you (the seller) leaves.
One solution is where you and the buyer to agree to the $1.2 million purchase price contingent on the terms of the consulting agreement:
$200k cash
$800k bank loan
$200k consulting agreement that might look like this:
If the revenues stay at 100% to 90% of the current year (the base year), you earn $200k. If they fall 89% to 80%, you earn $150k, and follow a similar “ladder”. If the new contract yields at least a 10% increase in the base year, you (the seller) gain 20% of the profits from that new customer.
This presents a win-win scenario for buyer and seller, and usually works with many lenders.