Online Business Deal: Different Structuring Options ExplainedBy Josh Snow
Whether you are about to start the exciting journey of purchasing an online business, or are planning on selling your baby that you’ve spent years proudly building up — you will want to make sure you get the best deal possible. In the world of Mergers and Acquisitions or M&A, the right deal goes a lot deeper than a simple offer and a list price.
Each deal has a unique set of circumstances and considerations, especially with online businesses. That’s why the deal structure is the key to laying out the conditions of the sale and making sure all parties walk away happy. At Dealflow Brokerage, we understand the importance of finding the right deal structure for every sale.
We have successfully bought and sold many types of online business from e-commerce to Saas, and structuring deals is a critical part of this process. So if you are thinking of buying or selling a business, it is important you understand the different ways you can structure your deal.
What financing options are there? How can you make sure the payments are met? Or that the business performs as promised? We have created an in-depth guide to take you through all you need to know. So whether buying or selling, you can feel confident you have got the best deal for you.
A note on online business sales
Just a note that this guide will focus on the best types of transaction structures for online businesses. In the traditional M&A world that deals with brick and mortar businesses, you may come across several typical types of transaction:
- Stock purchase
- Asset purchase
Stock purchase transactions refer to buying all the stock from a company’s stockholders, while mergers refer to the legal joining of two existing companies. While these are more typical for large brick and mortar-business deals, in the online world, the asset purchase structure is the most typical.
Asset transactions refer to the purchase of all the individual assets as well as any agreed-upon liabilities of a business. In an asset transaction, the seller remains the legal owner of the entity. Unlike a stock acquisition structure which transfers the ownership of the business entity to the buyer.
An asset purchase is one of the most straightforward and clean ways to buy an online business so this is the main structure we will delve into below.
What to consider when choosing a deal structure?
So, after you have done all your valuation, due diligence, and sale preparation, it is time to think about how to structure your sale. But how to go about choosing the right deal structure?
There are a number of things that are important to consider and will help you determine your deal structure. We have split them into two main areas; the risks of a deal and buyer and seller needs. Understand these and you will be on the way to understanding the deal structure you need.
Whether buying or selling, risk is one of the most important considerations when structuring any deal. Every business deal is different and when people are parting with their hard-earned business or a large quantity of money, tensions can run high.
As a seller, what if the buyer does not stick to their payment plan? Or as a buyer, what if the business they receive is not the business they were advertised?
The right deal structure can mitigate risks like these for both parties. It can help split risk more evenly and create trust on both sides to land on a deal everyone is happy with. So let’s dig into the main risk factors you should be aware of below.
Main risks for buyers
- Traffic and revenue
the consistency of traffic and revenue is highly important to consider when thinking about deal structure. Make sure to fully understand any spikes in revenue, churn rates, and ongoing expenses. Can you be confident that the business can consistently make what you expect each month?
similar to above, make sure you are aware if recent good results are consistent and not caused by a seasonal spike. If over a quarter of revenue comes from these spikes, this could be a concern. If it does, you don’t necessarily need to run away screaming. Just make sure that you have a plan in place to offset this such as seasonal discounts. Compare yearly results to see how the seller combated this.
it is important to know exactly where traffic, clients, and revenue all come from and if there is one source that disproportionately dominates. For example, does one affiliate or client make up more than 40% of the business’s revenue? Does traffic come from just one source? Or is involvement by the business owner key to bringing in revenue each month? Is there any reassurance that these things won’t change and lose you the biggest part of your income?
Main risks for sellers
the biggest worry for a seller is that a buyer will not pay the total amount agreed if they are not paying full price upfront. It is important to vet and trust the seller as well as mitigate this risk with the deal structure.
- Continued revenue
If the business does not generate what the buyer expects, they are far less likely to keep up with agreed payments. It is in the seller’s interest to make sure the business keeps performing as it should even after it is sold.
- Continued involvement
if the business relies heavily on the seller and their expertise, there may be a risk of not being able to fully exit from the business without it failing. Depending on the seller’s desires and goals, different deal structures can be put in place to find an exit strategy that leaves everyone happy.
Must Read: Five Critical Mistakes To Avoid While Selling Your Business
Buyer and seller needs
To choose the right deal structure for both parties, it is vital to consider the needs of both the buyer and seller. Does the buyer not have the full price upfront? Does the seller want a quick exit? Every deal structure will be unique and there is no one-size-fits-all structure. Let’s take a look at some come factors that can help us determine the type of deal structure we will use.
depending on available funds and the speed due diligence is possible, offering the seller a speedy timeframe and quick deposit can be of great value. At the same time, if a buyer is not able to move quickly, it may be possible to draw up a longer term agreement with added benefits for the seller, such as a price increase.
Money is important and a buyer will always be looking to negotiate down on price for the best deal. They also want to be certain that the business can be a success and will consistently make them the revenue promised.
As buyers don’t often have 100% of the cash up front, financing and delayed payment structures can allow them to buy the business they want, as well as provide them with security to see how the business goes before handing over the full price. It may also give them some free capital to invest in running the business at the beginning.
Does the seller want a quick exit or are they prepared to hold out for their asking price?
Price is paramount to many sellers however some may be happy to lower their price for a quick and easy sale where they can get the money in their hands asap.
As sellers know the ins and outs of their business, what role, if any does the seller want to play in the company? Do they want to say goodbye to their company and forget about it completely? Do they want to continue playing an active role? Are they key to the business’ success? There are various structures to incentivize continued seller involvement or let them exit with a clean break.
This is key in any deal. A seller must trust that the buyer will pay what they promise, while the buyer must trust that the business performs as promised. Due diligence is important on both sides to gain this trust, and various deal structures can help keep both sides’ minds at ease.
Benefits – Other than the financial side, are there any other benefits that might interest the seller that could sweeten the deal? Sometimes things like industry contacts and introductions, use of systems or platforms can inject some extra goodwill and create a more favorable deal.
Deal structuring options
There are a few main ways to structure deals that help minimize risk for both buyers and sellers. These different tools help buyers and sellers gain leverage and security in their deals. It is not only important to understand all the financing options available and different deal structures, but also to know exactly when to use each one. Let’s take a look at the main ways here.
The first of these is an earn-out. In simple terms this means a buyer paying a deposit payment up front, and paying the rest in a series of agreed installments over time. Depending on the deal this could be over weeks, months or years. Think of it as putting down a house deposit and paying mortgage payments over time.
This structure particularly helps mitigate risk for buyers as they do not have to invest all their cash right away. It allows them some leverage to make sure that the business will perform as promised. It can also incentivize the seller to make sure the business continues to be successful during the payment period.
The earn-out can allow buyers to use their remaining capital to invest into the business, and potentially help make up the earn-out payments with the profit made. Ok so this sounds great for buyers, but what about the benefits for sellers? The earn-out structure has many different forms and structuring options to make sure they are also beneficial structures for sellers.
Holdbacks are good leverage tools for sellers in an earn-out situation. They usually refer to holding money, or commonly with online businesses, the domain during the earn-out period. The domain can be held until all payments are received from the buyer, giving the seller a great deal of security.
This can however cause some mistrust in the buyer who has no guarantees they will actually get the domain once they have paid. But this mistrust can be minimized by using a third party to manage the holding process and effectively hold the domain for them until payments are completed. Let’s see the best options for this below.
- An online business broker – A great way to mitigate risk for both parties is to use a specialized business broker like Dealflow Brokerage. Brokers can help manage the whole earn-out, holding the domain and transferring across to the buyer once the payments have been made.
- Escrow – Escrow services essentially involve a third party holding the domain and passing it over to the buyer once they complete their final payment. The downside to this is that they are not always well-adapted to digital assets.
- Lawyer – Instead of an escrow service you can also hire a lawyer to do the same job as an escrow service. They are more flexible and more sensitive than escrow services, so it can be a safer, easier option. They can also offer advice to both sides.
As opposed to holding the domain, it is also possible to hold the whole price of the business in escrow or with a third party. The money will not be released until certain agreed milestones are hit in the business. This is a good way for both the buyer and seller to have more security and confidence in the deal. In this case, using an attorney over escrow can be a good idea, as a lawyer is able to make more nuanced decisions. This can be important regarding digital assets and a lawyer can offer you more protection.
Different earn-out structures
Earn-out structures are probably the best way to go when it comes to handling an online business deal of less than $10m. A typical earn-out deal involves the buyer paying a significant lump sum of cash upfront, and the seller essentially ‘financing’ the rest by letting the buyer pay it off over a period of time.
This takes trust from the seller, although using third-party services like escrow, lawyer or broker to hold cash or a domain can help mitigate the risk of not getting paid. Earn-out payments are usually tied to the profits made by the business. If these are high, the payments are usually made more quickly.
Earn-outs are best when the seller is happy to be involved with the business post-sale. This is because they will have a vested interest in the business succeeding; getting the rest of their cash. However, their involvement should be clearly agreed upon as well as fairly compensated.
An example of an earn-out could be a website selling for $400,000. The buyer may pay a lump sum payment of $300,000, with an earn-out of $100,000 to be paid over a year in monthly installments if it hits certain earning targets. Usually earn-outs are a good deal for the buyer as the payments don’t usually accrue interest.
A seller however, may prefer to charge interest on an earn-out deal structure, to boost the list price of their site.
Earn-outs are great for:
- Businesses that are heavily reliant on the seller’s personal relationships or niche expertise that are hard to replicate
- Buyers who can add value to the business and are happy to share growth with seller
- Encouraging the seller to offer advice and consultation to grow the business after the sale ensuring a smooth transition
- Sellers that prefer to minimize the tax impact of the sale by having an earn-out over several years.
- If the business fails and the buyer goes bankrupt the seller may not get their payments
- Seller may end up being more tied to the business than they wanted
So what are the different ways to structure an earn-out? When should the payments be made? What kind of role will the seller play during the handover period and going forward? Let’s take a look at some of the main ways below.
Laying out milestones in the business can be a great way to structure an earn-out. A milestone structure usually involves regularly scheduled payments from the buyer to the seller. But these are only paid if certain business milestones are met by the same time.
Milestones could be any sort of pending task or achievement in the business. Anything from a shipment of product arriving to the warehouse, to achieving a certain amount of revenue or profit. While milestones don’t have to be huge, they offer the buyer security and trust in the seller that certain milestones can be met.
They are particularly beneficial for a buyer who is purchasing a relatively new business, for example. The buyer gets some security in the performance and growth of the new business, and the seller is incentivized to help the business succeed so that they get paid.
If milestones are based on the business generating money, they can either be linked to revenue or profit. Buyers and sellers will differ in opinion here; buyers tending to prefer profit-based milestones, sellers preferring revenue-based ones. Why this difference in opinion?
It is down to the fact that calculating net-profit takes business expenses into account while revenue calculations don’t. Therefore if milestones are based on profit, a buyer may decide to heavily invest in scaling and improving the business, and may not meet the milestone threshold.
For example, if the business tends to make $9000 net profit each month with an agreed milestone of $7000 monthly profit, if the buyer suddenly spends $5000 on the business, profits will be reduced to just $4000 and the buyer is essentially off the hook to pay that month. Revenue however is much harder to manipulate making it a safer option for sellers.
Another possible deal structure is called rollover equity. This type of transaction involves the seller selling most of their business for cash, while maintaining a portion of the equity in the business. This essentially means the seller can liquidate most of their assets but still remain a minority owner.
This seller-retained equity allows them to still reap some of the benefits of the business going forward, which can be especially beneficial if the business is growing quickly. So how does this work exactly? And what is in it for both the buyer and seller? Usually, the seller will see this equity in the form of monthly dividends.
These will be paid alongside the agreed cash price of the business of course, and will also continue after it has been paid off. In return, the seller will likely still play a role in the business, but usually more of a consortial role. This is a good way for the buyer to make use of the seller’s expertise, using them as a kind of consultant. It also makes sure that they are still tied to the business and are motivated not to see it fail.
Any rollover equity agreement should be agreed on very carefully. The seller’s continued role must be clearly defined in writing to make sure there are no misunderstandings going forward. It can be difficult for a seller to leave the business after this kind of deal. They would need to sell the equity to the owner in order to liquidate it which can be a difficult process. This type of deal is not recommended to anyone looking to have a clean break and no more involvement in their business after the sale.
A perpetuity-based deal structure is another type of deal that allows the seller to keep receiving benefits from the business even after it has been sold. Instead of having continued equity with the business, however, the seller will provide an ongoing service for the company in exchange for a fee.
If the seller typically performed a key task in the business that requires specific skills and is hard to replicate or hire for. If the buyer lacks these skills, it can be a great way for the buyer to make use of the seller’s expertise. Even if it is only during a period of transition. The role of the seller could be anything from receiving a monthly fee to keep backlinks alive on a blogging site to backend development updates.
This deal structure can be a cheap way for the buyer to keep the seller’s expertise on tap. It can be beneficial for the seller too, as they will get some continued gains from the business. However, if the seller is facing burnout and was hoping to get away from the stresses of the business, they may prefer to go with a different deal structure entirely.
For larger online businesses, balloon loans can be a great earn-out structure. These loans usually take place over a short period of time such as 30 to 120 days. A balloon loan does not fully amortize over its term, aka the payments made over the period will never cover the full loan amount.
Therefore, at the end of the term a large ‘balloon’ payment will be due to cover what is left. Buyers can use this to reduce their monthly payments to the seller. They may link these payments to the growth of the business. Should the business not make sufficient profit, the buyer wouldn’t have to pay that month.
An example of balloon payments could be an online business being sold for $1m, which makes $40,000 per month. The buyer might be able to pay $800,000 upfront, and agree to pay the remaining $200,000 over 120 days. They might agree to pay $6000 per month should the business make $30,000 each month. But at the end of the 120 days, they would still have to pay whatever was left, regardless of profit.
This type of deal structure is where money meets skill. Investor/ operator partnerships usually start with individuals who have the skills to run online businesses but are lacking in cash. They then find investors to partner up with to buy businesses and improve them to make them even more profitable.
Usually an investor will put anywhere from 40% to 100% of the cash into purchasing a business, while the operator comes up with the rest. Operators with little capital may use a form of seller financing to pay their section of the price. The operator will usually be in charge of running the business and undertaking daily tasks or building out teams if necessary.
The investor on the other hand usually plays a hands-off role. The two partners will formally agree on how to split the equity, which can differ between deals. This type of partnership is becoming more and more common in the online world. Particularly because bank financing can be difficult to obtain when there are online assets involved.
Banks are hesitant to give out loans when there are no valuable assets to seize should payments not arrive. So finding an investor can be a good solution for someone looking for financing. There is another way that larger investors also operate. This is by continually looking to purchase new online businesses, which they pay for in full.
They then have teams of operators who are paid a salary to work on and improve the businesses in question. Usually, these operators do not have any equity in the business but may be given performance bonuses.
Advice for sellers
- If you are looking for a clean break from your business and would like to be completely removed from it in the future, you might want to steer clear of the earn-out structure as this usually requires some form of involvement from the seller. Especially a rollover equity-style deal.
- Sellers considering an earn-out structure might consider charging interest over the earn-out period. It can allow a buyer to buy a business they couldn’t otherwise afford while you earn more than your original list price.
- If you don’t trust that the buyer is able and capable to successfully maintain or run the business, it might be best to avoid the earn-out structure. If the business fails, they probably won’t be able to pay you what they owe.
- If you are selling a high-value website in the 6 or 7 figure range, it is highly likely that you will have to accept an earn-out. As mentioned it is very difficult to get bank loans and financing in the online business industry. Therefore most buyers will need to implement some sort of seller financing. Make sure to vet the buyer properly to make sure they will be able to run and grow the business, but this may be necessary to close the deal. For high-level transactions, it is also highly recommended to use a broker.
- If you are using a milestone deal structure, it is more beneficial for sellers to tie payments to revenue instead of profit. Net-profit figures can be easily manipulated by expenses while revenue can’t.
Advice for buyers
- Make sure you leave some extra money to invest into the site. You will almost always find you need a store of capital to invest money into the business to keep it running and growing from anything from a redesign to content. For buyers who are very strapped for cash, think carefully before jumping into an earn-out.
- If your business is reliant on the sellers personal relationships, an earn-out structure can be particularly beneficial as it will give you a transition period where they are still involved in the business. Sellers will be incentivized during this time period not to let the business fail as otherwise they might not get paid.
- If you are ready to move fast and pay upfront, you may be able to negotiate a discount with a seller. Sellers will often value upfront ‘safe’ cash over the promised cash of an earn-out.
- It can be very difficult to get a bank loan or financing in the online business sector. Therefore if looking to purchase a business, it might be wise to either use an earn-out structure or find an investor to partner with.
What is the best deal for you?
The best deals are deals that make sense for you and your situation. These will look very different from person to person depending on their situation and goals. A seller looking for a quick exit from their business, for example, might be happy to offer a discount for a fast sale. Another seller who wants to see their business flourish on the other hand, maybe happy to offer their time and services as a consultant through an earn-out.
Equally a buyer who has the full skill set to take over the business may not be worried about keeping the seller on tap. And a buyer who wants to purchase outside of their means might not mind paying interest on an earn-out if it means they can buy the business they want. The possibilities are endless.
Negotiating and open conversation is a big part of the deal-making process. As a buyer make sure you request enough data and proof of performance from the seller. And as a seller make sure to vet the client to be sure they can handle the business and have the skills to grow it.
Whether you are buying or selling, make sure to always enter into negotiations with a clear head and clear limitations on your maximum price or minimum sale. Of course an ideal outcome would be a win-win deal for both buyer and seller, and sometimes a very favorable deal for both parties can be achieved. But more often than not, one side will have an advantage. When heading into a deal, look into all the aspects that you can use as leverage to gain an advantage over the other partner.
So if you are getting ready to strike a deal either selling or buying a business, make sure you proceed with care. It is always best to get official advice from your attorney, financial advisor, tax advisor or business broker. Crafting the perfect deal is a time-perfected skill and can be difficult to get right the first time without outside help.
If you are nervous about this process, a business broker like Dealflow Brokerage can walk you through each step. Make sure you have done your research and you know exactly which tools you can use as leverage to sweeten the deal. Whether you are buying or selling, this is one of the most exciting times of being a business owner. Deal structure is highly important and yet little-discussed. Don’t fall into any traps and go get the deal that’s right for you.