How You Can Buy a Business With the Profits From the Business

Colin and Brent discuss seller side financing, pros, cons, and why everyone does it.

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Hello and welcome back. This is Colin Keeley here, and I'm Brent Sanders and we are two guys buying and building wonderful internet companies. Yeah. And this episode we wanted to talk about seller side financing, at least one of the topics that,  we use on all of our deals. And I thought it'd be a good topic to talk about just cuz before knowing Colin, I don't think I knew.

A, that this existed and b, that it was so commonplace that it was like an established thing. So, just for reference, we've used seller side financing on all of our deals. We plan on continuing to do it, and it, it, it's kind of a unnecessary part of our deal. And now that we, we do, do it, it's, it ensures, at least to me, that, if we need to find a lost password within the first, year or so of owning a business, we still have somebody involved that can, can help us track that down.

Or whatever. Usually it's the err S3 bucket that, is still being linked to in the emails or the marketing materials or something crazy. But,  I, I'm curious, like how did, is this something that you found in, in business school or you just knew about it? So going all the way back to business school, like I was in, it was like private equity and venture capital lab and they actually divide you up and they throw you in different rooms and they like rarely combine you, but I like sat in out of PE room once.

It's like, Holy shit, you could buy a company with its own profits. Like, yeah, that sounds way better. Like most of our stuff's what's going to zero in venture capital, . But yeah, never really put too much thought into it. Never really took those classes. But I, I took some notes here,  as far as like buckets to like structure our conversation.

So how's it work? Why do we do it as a buyer? Why a seller would wanna do. And then a downside to the seller. Yeah, so like, just at a high level, I think we covered this a few times in different variations in the past, but how it works is not that different than like a mortgage or something. But you know, houses aren't, unless they're like short term rentals aren't a profitable thing, but it's like you buy something upfront, you have some upfront money, and then you pay off the rest over time.

So instead of a lump sum, you spread it over time, over a number of years with a down payment. And then there's different terms. There's the down payment, the interest rate, the, term as in like duration, and then collateral is another, , mechanism to go up and down. Yeah. And like we, I guess when we look at this is it's like we don't, Ty I know we've never tied anything to like the performance of the business.

Cause if you're selling. I mean, unless you're making some guarantee about, hey, these clients are never gonna leave. Do you know, is it, is it common that people don't tie anything to performance because the salary is leaving? Or is, are there usually like a clawback here for like, Oh, well, you're warranting that this is gonna stay at a certain run rate, or certain employees are gonna stay and if not, I go, gonna claw that money back.

Do people use seller financing for that or is it different? So I have, it's in my course, there's like a million flavors of this, like an earn out. I see the traditional one,  where it's like based on the performance of the business, the version that we do,  Generally just like, almost like just a payment structure.

So we're just gonna pay you in, , some period of time. And it's not contingent on the business, but it's, we're talking about like why you do it as a buyer. So one thing you kind of said is a vested seller interest. So the seller has a, , reason to reply to your email and tell you passwords because if the business just fails, there's no money to, , come collect later.

So that's not good for. Juice returns is the obvious one. You don't need as much money up front, , to invest and to buy the company so you could pay off some or all the profits,  all the seller financing with the profits. There's also inflation, like pretty extreme inflation going on right now.

So like money we have to pay in the future isn't into actually as valuable as it is today. And then protection is another big one. Beyond like them just replying to our emails, which is nice, but you can structure it so you could claw back some of the money. If like reps and warranties are violated, if they lied to you somehow, like at least you have that money outstanding.

You could come or you could make it contingent on some things like, , clients don't leave or 90 days, six months, one year. Something like that. Yeah. Yeah. Interesting. Yeah, I mean, I think we've found good alignment with. Our sellers around it. And, and , I think it's, it does put us both on sort of like the team.

I, it's something that sellers always say, they're like, Oh, we're happy that you're taking the baby and gonna grow it. And, and it's gonna be in good hands. But this almost like puts the money where the mouth is a little bit, where it's like, how, that it sounds, it's like are you paying lip service and just saying that to make us feel good or do you really believe in us?

It's a kind of, feels like a little bit of an investment. I mean, there's definitely putting a little skin in the game to also to get a, a purchase price that they want. Right? Like that. Let's be clear. I think this helps us get to a, not that we're, we're overpaying, but like getting to. Bridging gaps between valuations.

Sometimes it's like, okay, we can, we can maybe stretch if we don't have to come up with the cash right away, or we can pull it from the business over time. It's like, I like to make deals that everyone's happy with. Like, that's my philosophy around this. And that is a great tool for us to, to get there is my feeling.

Yeah, so price and terms are like two different levers. So you could, you could have the highest price possible, but you know, you're gonna get screwed on terms you're gonna paid out over time. Or you could have the best terms possible. You have a hundred percent of money upfront, but you're not gonna get as much money.

And so occasionally you talk to founders and it's like, I want the max money and I want it all up front. It's like, well those are, kind of opposing, things there. Yeah. But the biggest reason to do it for the why the seller's a higher sale price. So you get more money if you spread it.

And then it also, like related to that, it wildly opens up like a larger buyer pool. I think the hardest thing as a seller is really to find like the right buyer and the right buyer. Plus like having a hundred percent of the capital upfront is a really hard combo to fine. So if you could, if you, you're confident in the quality of the business and you're confident could pay off some seller financing, you could kind of share in, the future profits of the business and find the right buyer.

It's also. One more thing is it's tax advantage. So you're basically spreading out the tax hit over a number of years , which is beneficial. Very cool. Very cool. I mean, when it comes to the seller jumping into the seller kind of downsides, I know there are a couple other things we wanna talk about, but that's probably the biggest one as a seller to think about is like, you're, you're guaranteeing, not guaranteeing, but you're underwriting alone.

Right. You're basically,  yeah, it's, it's financing, right? So I would say the biggest thing that, at least within our experience that I think is advisable for sellers to do is due diligence on, on the buyers and like talk to other people that they've done seller side financing with. I think that's probably the easiest thing you can do is just ask.

Give a reference or two of people that you've done this with before, make sure they've been paid. Beyond that, maybe even like track record, credit check. I don't know. I mean, you, you definitely, I don't see a lot of buyer diligence. Maybe some brokers do that, maybe some better brokers than we work with.

But,  that would definitely, if I was a seller that those would be my first steps. Yeah. So that increased risk is by far the biggest downside. And like, it really depends who your buyer is. So the best case is a serial acquire with experience and like the asset class before. So like us in software, we bought it before, we paid off seller financing before the plan on buying like many more software companies in the future.

And so like screwing someone is not, and not a great way to, build your reputation. But like, this is definitely a thing in search funds. So your goal is you pop outta nowhere. Your goal is to buy one company and then you disappear again. And if you don't have experience like in that asset class before, you've never run a software company.

Like there's, there's definitely some chance you run it into the ground. Yeah. And so that would be viewed as significantly more risky. Yeah. Yeah. I, I would imagine, that's something you're gonna have to assess as a seller. I. Collateral is, is an interesting topic around this, is like the business essentially becomes the collateral, right?

It's like if you default, I guess it depends on the terms you agree to, but the business can be a lean,  yeah. What are the other collateral options that you have? It used to be anything. I, I'm not an expert on this, like UCC lean, but it's basically like your first priority to get paid back, if something happens or whatever in the business.

Other way is like, we've signed promissory notes in the past where it's like if we default,  you don't even have to go to courts, is my understanding. They just get that percent of the business back. Yeah. So that's like a pretty clean one, but I, I think the reality with all this stuff, or most of it with the exception of that, like.

Pre-signed promissory note is like, you're gonna go to court anytime you have to like enforce a disagreement in a contract. Yeah. I, I don't know. There's like, you could do a million different contingencies, but it's not something, I don't know. I haven't put a ton of thought into like a situation where we don't end up paying.

It's not something I ever really,  I plan on like, I think we will grow effectively. Every company, whoever buy nothing concerned about failing to pay one in the future. Yeah. I mean, I, I think. The, the collateral side of this is like, to me, as a buyer, as a, on the flip side of the collateral, it's like you're representing that with you at the helm.

This business is doing well and you're kind of, it's a, it's a showing to the buyer that like, you have confidence that it's gonna, it's gonna be fine. Like, if you're really saying, I don't check support, that's two hours a month that I do anything and it's growing like, right. Great. Like, then you should have no problem.

Doing some seller side financing and holding some of this back to, to see how it goes for you. I mean, then again, you're selling the business, right? So from a, I can see the buyer's perspective where, maybe it's, it's like, Hey, I just wanna cash out. And the I, I keep going back to that's where, where purchase price, like that end price, like you can really juice that price, get more money in your pocket and more tax efficient way by, by doing this, which is why AO was kind of blown away by.

Commonplace, how commonplace this is. It's like, it's, it's, it's a good thing. I feel like it's a pretty healthy thing to add into a deal. Yeah. So you kind of alluded to it, but it's not a hundred percent like a clean break if you're like hoping to, Walt's onto the beach and never talk to those guys again, it's not a great recipe to do that.

But for us as buyers, I would expect us to always have seller side financing. Like, I don't know what market is exactly, but probably 20, 30 plus percent. It's pretty standard for any deal of like any kind of real size for really small stuff. Small like chrome plugins or something. You just wire the 20 K over or something.

There's no seller financing, but six figures and up is always seller financing and I would view it as like a pretty big red flag to be like, Oh no, I don't want, I want all that money up front. Best of luck to you guys. That is, unless you, if you had a competing offer, like, cuz I then I think it's, we, we talked about this on a prior podcast, but, we, we lost a deal to,  like a Constellation software, like a, a Goliath player in the space where it's like they can cut a check for 4 million without batting an eyelash that Right.

It's like no big deal. And,  it's really easy for them to, and that probably is a reason why they're easy to close. Right. So it's like, Fast forward, let's say five years from now and we're, able to deploy a similar amount of capital. I wonder if we'll feel, feel the same way. I, I feel the same way.

I think I will. Right? Like cuz it's, hey, this is a healthy thing to have there. It's like aligning incentives. We're not gonna get stuck with a kind of a, a lemon, so to speak. Or in a situation where, it's so funny, especially with technology, like how important a little piece of information might be to us.

It, six months down the line, we run into something and it's like, Hey, are you aware of this? Or do you know anything about it? Do you know the history behind it? And it's a 10 year old code base, and it's like, that could save you easily a hundred thousand dollars of development time software, whatever it is.

I was just like, No, no, no, don't go down that path. We were down there and it's like, I obviously you want to uncover that within like the 30 days of diligence or whatever, but I mean, on certain projects, that's just not gonna be feasible. So it's like combining a fast close with no seller financing and an old code base or an old product, like it just seems a little reckless.

Yeah, it, it is. Quite rare, I guess if you have a big likes, w will do this. You just show up with like a truckload of cash and be like, Hey, you have 24 hours. Are you in or are you out? And it's like, yeah, I guess you probably get some great deals if you just do a hundred percent, know, cash upfront. Yeah.

That's one another way to approach it. Yeah. Hey,  you're gonna have some, some bumps along that road, but I guess the, that's just a, a different playbook, but I dig it. It's, it's an interesting way to just be like, Here's your money. Go to the beach. Like, go, enjoy, do something else for your life.

Like you, you've done it, you've reached the top of the mountain. Here's your check. I, I was reading about this real estate guy who,  he puts a hundred thousand dollars in account. He looks at some building and he really likes it. Does all his diligence up front. And then he offers, some amount that he thinks is fair and low.

And he says, if you sign this,  you could go grab that a hundred thousand cash today. And just that like a hundred thousand upfront is like, even on multimillion dollar deal is really impact people. Yeah. Not our approach, but something. Think about . Yeah. If you think about it, it's like, hey, you can go buy yourself something nice.

Maybe a nice watch. I, I don't know what a hundred K buys you these days. I was about to say a Porsche or something, but not really. Like it's, it's still either way. I think that it's nice to see the cash. Maybe that's something we need to include in our offers is. Sure. There's gonna be some seller side financing, but here's a, Yeah.

A briefcase full of unmarked  unmarked bills today. Yeah. Truly Speaking of flying, you were,  you were in Austin recently, right? You were, you were visiting. Yeah. So my wife's finishing up,  her fellowship. She's a pediatric neurologist, so she's interviewing at different fo at different places. This was an interesting one.

So they do like all the doctor interviews and, but then they take you to dinner, like more as a culture fit, which I think is actually a big deal. They were playing it down was not a big deal. And the. Effectively like the head doctor, this is a unique situation where they used to work at UT Austin. It was like eight pediatric neurologists.

They wanted more freedom to kind of run how they wanted to run. So they spun out a UT Austin and started like a competing clinic, and then it became, multiple competing clinics. So then they were doing. It was really nice for the doctors, like one to one nurse to doctor. So instead of sharing a nurse, you have your own.

So it's less work. And then they have fewer call shifts. So call shifts. There's all this like slang and doctor world. Oh no. Yeah. Call shifts are working. I'm familiar with it. So they like work half as many nights as most other clinics,  and holidays where, you know, you can't, you can't leave. Like you have to be ready to hop back into an emergency.

Right. You have your days on hold, on your own call. Yeah. And so like doing that for one month outta the year versus like two months outta the year is a pretty big difference. But what was interesting is they did. I don't know when they started it, maybe like eight years ago, 10 years ago. And Austin's been booming.

And they made the decision to sell like three years ago. And so it was calling her a CEO is not right, but like the business manager, like the real owners of the doctors, but she's like the business manager. And I was like, Why, why did you guys choose to sell? Right? It's what was the deal? Like, where were the big expenses running?

It's independent and the largest problem is benefits. Benefits are super expensive,  to pay across doctors. And then she's saying the it and tech and like getting that all set up and paying is really expensive. And her last one was DR. Salaries, but I am not really sure that changes,  whether you're a bigger practice or smaller one.

And then, so they sold to effectively a roll up. So they're rolling up pediatric neurology clinics like throughout the. And,  why they did it. It's, Austin is like a great growing market, but they saw a bunch of other competitors coming in with like way bigger balance sheets that were gonna be throwing more money around.

So it's not, it's kind of like us, like, do you wanna be competing against a VC back Goliath? Or, you wanna be in kind of a sleepy corner. And so it's great if you're like, you're riding the wave, but until someone much bigger comes and kind of wipes you out,  yeah. Yeah, they did an all cash deal, no equity.

They all seemed, very happy about the whole thing. I'm sure equity would've been more lucrative, but I bet the roll up didn't wanna provide. Interesting. Yeah. So did they still get that? Like are they still able to do the flexibility of the call hours or is it that's all out the window? Yeah, nothing has seemed to change.

They still run independently. I didn't ask how they're compensated cuz they're like, the senior doctors there, but I assume it's like a profit chair situation. What was funny is like they're gonna make Holly an offer. Sure. And they were,  basically coaching her on how to negotiate cuz now they're negotiating against like, the head office instead of their like amongst Oh, interesting.

Yeah. Yeah. I, I appreciated that. That was nice of them. Yeah. Cool. Well I hope it goes well and, are there other markets she's thinking of,  interviewing in? Or is it only, down. I'm pretty high in Austin as far as like, yeah, what we're doing, software, private equity, that's like where the big boys play and there's also a lot of bootstrap founders out there.

So it's like SaaS companies, but more with the cash flow focus. So it's probably one of the best, like hotbeds for us,  as far as like deal sourcing as well. So I'm pretty high in Austin. But our family's in the Midwest so we'll. Yeah, well you can bump, bump elbows with Joe Rogan and, and whoever else has moved out.

Cause a lot of Californians moved out there. Right. It's always like during a covid. Yeah, it's, yeah. Very cool. It's a tiny city. I mean, it's like, I don't know, St. Pete's, Florida to me, like going around. You think it's like this big developed place cuz people talk about all the time. Yeah. But like even the nice areas, it's like, oh, there's just a car like rotting in that yard over there.

Yeah. Yeah, yeah, yeah. It's not, not super well developed. Great food town though. I mean, it's, it's, if you're going from Chicago to Austin, I don't, you won't skip a beat like great food. I haven't been there for, for years, but not, not even the barbecue scene. Cause that's, that's its own thing and you gotta be kind of super into it.

But,  Yeah, it's a, it's a cool town. Hopefully it works out. Fingers crossed. Yeah, I, I'm pretty high on it. One other thing, like I have a buddy who runs,  a large telemedicine company,  that he moved from,  Chicago to Austin. And so I was asking him like, he's only been there three months, but he bought land there like three years ago or something.

It's like how this, his experience been. So just like going through his feedback quickly is the heat was harder than he thought. Like just going out in the summer afternoon. Becomes not option, but one distinction he said is like, he's got a bunch of kids and so, Chicago at the bad times the winter or like New York or other places.

Yeah. But kids are in school so you can't flee. But actually in Austin, kids are outta school for the summer. So most people leave. Yeah. And like go somewhere else. That was kind of cool. He was saying he is way happier and healthier and he is thinking it's the sun. Like he eats better. He exercises more.

I've noticed this like people are crazy fit in Austin. They're also very happy and friendly. I bet it's the sun. Mean, my guess it could be Texas too, though. I mean, like, people say hello when they're, walking down the street. There's something about, Texas is known for a lot of things, being bigger, being whatever.

But people, I've always found Texans to, to be willing to say hello. I don't know friendly's the right word all the time, but, I think it's, it's the intent. They're definitely. Willing to talk to you and, and make eye contact and, talk to anybody? Pretty much, yeah. I, I would say very few people in Austin are like Texan, Texan.

Everyone has come in the last five years from all over, like a lot of Californians and,  but yeah, you said it's relatively easy to make friends cuz everyone has moved there kind of recently and so it's like that, freshman year of college, first week kind of vibe. Like people are more open to making friends.

He said it, it's cool to be in a growing city. Like it's way easier with the wind at your back. Like whether you buy real estate, you make like a dumb purchase or a good one, or you start a business. It's just like, well, people are growing, everything arounds you growing. So you kind of look like a genius and everyone's happy and kind of making money together.

So that was cool. Yeah, I mean, that was the bulk of it. The, the other sneaky thing that like if you haven't been there before is like there's a weird amount of water. Like there's a river that people dam lakes. So the riverfronts is like a big thing that people walk and like work out on, or Barton Springs is just awesome.

It's this like huge public pool,  that's extraordinarily cold. Like if you jump in, no one reacts, but it's like 60 degrees. It's shockingly cold. . Have you never done it before? Man, the only thing I remember, or that I feel like is, is most like memorable in my childhood is, is did you ever see the movie Slacker?

This was like a 1990 movie. It came out in the nine early nineties, and it was like independent film, but it, you gotta go and see it. Just from the sense of like, seeing what I think. Austin was kind of known for, which is maybe a little bit more Portland e like the movie. It's just like these under 30 kids that they do nothing all day.

They're just like, What's going on? Nothing. Listen to some music. It's just like such a great,  like slice of, I guess Gen X, of like at its height of just being, when people would say, Oh, they're just a bunch of slackers. But it, it, it. It's just a weird movie. And I, I go back to, I watched at least like once a year just to kind of like remind myself of like, it's, I love certain movies like that, that just have that flavor.

And when I went to Austin it was nothing like that cause it was like, obviously this was 19 90, 91 or something like that. But I think there's still a little bit of like a keep and weird, a little bit of like a hate ashbury kind of vibe to that town that I think's cool. Like that's, that's definitely on the.

I live in Cleveland. Cleveland also has some funky weirdness. It's not on the scale of, of some of those towns, but it has this other sort of like , like you can talk to anybody here. It's like people are Midwestern and,  weird and, nuanced. So I don't know. I like smaller cities like this that have, have some funk to 'em.

Yeah, I lived in Minneapolis for a long time. Reminds me a lot of that. There you go. It's just the opposite issue. Hot versus cold. But yeah, even the neighborhoods look very similar in like how they're structured. Yeah. At least within the city, if you get in like, it's like the Northwest Hills, it's, there's like a shocking amount of money.

The houses are incredible. It's much more like, I don't know, Malibu or something. Wow. I was asking about that. I was thinking it's like oil money. He said it's more, much more tech money. It's like all internet companies, people moving out there, there's been more of a history there, I guess, of tech companies as.

Yeah, I have a, an in-law who's been out there for, I don't know, 20, 30 years. Raised his family there, but he, he ex Harvard business guy who's been a tech ceo and they built a, it looks like a mal, a a huge pool and everything. I think they, they. They seem to get out in the, in the summers as well. But you know, it, it has a great,  history.

We were out there with the, the venture fund at some point, talking to investors. So it's like it's earned its place on the map for, still being a small city. But, being a, a location for capital for investment in tech, and I'd imagine that's only grown over the last five years.

Yeah, it's cool. I, I definitely enjoy being there, so we'll see. I think there's a reasonable chance I'm living there next year, but we'll find out, see how the negotiations go. Yeah, I'm pumped. I love negotiations. I love for it . Very cool. I think that's all I got. You got anything else you wanna chat? No, that's it.

Cool. Yeah. We'll stay tuned. We'll find out how it goes. Yeah. All right. Take care everyone. Thanks for listening.

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