How can I balance risk and return when I'm buying a business?

There are several different tools that can be used in a business acquisition.  Each of these tools is designed to either mitigate risk or maximize potential return and certain tools may only apply in certain situations.  A few examples are as follows:

• 100% Cash Deal - this is the riskiest purchase method, and can have the greatest returns.  Other than being bound to the warranties and representations on sale, the vendor is completely disconnected from the future returns of the business.  Whether the business goes on to be successful or not will not impact the purchase price.  Accordingly, an acquired business that provides greater-than-expected returns will be solely for the benefit of the acquirer. 

• Earn-Out - this tool is favoured when the purchaser wants security in regards to the future returns of the business.  The purchase price will be based on a percentage of revenue, profit or some other measure, and will be paid out over a set period of time as the results as reported.  Accordingly, the risk of future returns being lower than expected is mitigated because the purchase price will decrease.  Of course, if results are better than expected, purchase price can increase.  There are many potential complications in such an arrangement, each of which can be discussed and planned for with a business valuator.

• Vendor Take-Back - this tool assists when other forms of financing may not be attainable.  The vendor agrees to be repaid a portion of the purchase price over a certain period of time.  The interest rate and repayment terms, as well as any penalties for lower-than-expected results, can all be used to bring the negotiating parties together and to balance risk and return for the acquirer. 

There are other tools that can be used, each of which can be used in conjunction with any of the above tools.  The key is to plan the approach at the outset, because it may be hard to try and renegotiate the purchase method after a vendor has already agreed to a certain approach.  Please contact us if you are thinking about acquiring a company and we can help guide you through this process. 

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