Quantifying Key Person Risk In Small Business Acquisition Valuations
Key person risk is quantified by deducting market replacement wages from normalized cash flow and discounting remaining earnings for customer concentration.
seller note
Meaning
Debt owed by the purchasing entity to the previous owner constitutes a secondary financing arrangement in a corporate acquisition. The seller note functions as a deferred payment obligation where the buyer retains a portion of the purchase price to pay out over time with interest. This instrument bridges valuation gaps when access to external capital remains restricted or terms appear unfavorable.
Payment Structure
Installments allow the acquirer to preserve cash flow while providing the recipient with a steady income stream post-exit. Repayments occur according to a fixed schedule or based on specific revenue milestones defined in the purchase agreement. Subordination clauses often require that senior lenders receive priority if the company encounters financial distress, which increases the recovery risk for the holder.
Operational Exposure
Holding this obligation links the financial health of the sold entity to the final payout received by the founder. Management decisions made by the new owners regarding debt levels or capital expenditure directly influence the capacity of the company to meet its scheduled obligations. Founders maintaining this interest experience a shift from absolute equity control to a passive creditor position where active oversight disappears but performance monitoring remains necessary to ensure the solvency of the counterparty.
Risk Allocation
Default probability increases when the company fails to generate sufficient margins to cover interest payments alongside other fixed costs. Provisions in the contract might include covenants that trigger immediate acceleration if the buyer misses a payment or liquidates assets. Legal recourse requires significant expenditure of hours and capital to enforce collection, making the initial due diligence of the purchaser an essential step in protecting the long-term value of the payout.