For accountants, attorneys and wealth advisors
The Annuity Sale,for advisors
Written for the professional deciding whether a structure like this fits a client. Below is what the instrument is, how the payment is computed, what it is worth in present value terms, and the cases where the answer is no. If it does not fit, this should make that conclusion faster to reach.
The instrument
| Price | Fixed at closing. Becomes the principal of a seller note. |
|---|---|
| Cash at closing | None. |
| Note rate | Fixed, not below the applicable federal rate for the month of sale. |
| Payment | Fifty percent of the business's free cash flow, uncapped on the upside. |
| Term | Ten years. Unpaid principal is due as a balloon at maturity. |
| Security | First-priority perfected lien on the operating company's assets. Your client is a senior secured creditor with foreclosure rights. |
| Operating control | The buyer takes full operational and financial control at closing and installs its own operator. Your client stops running the business on day one. |
| Fees | No broker or intermediary commission. Also none paid to you: see the last section. |
How the payment is computed
Free cash flow is EBITDA less capital expenditures, less the net change in working capital, less third-party debt service. It is computed before the seller note, so the payment is not defined in terms of itself.
The first twelve months run at a stated baseline payment, paid monthly. From month thirteen the payment resets quarterly on a trailing twelve months basis rather than on the quarter alone, which removes seasonality and spreads lumpy capital expenditure across four quarters. A downward adjustment carries thirty days written notice. Quarterly figures are management-prepared, so the annual reviewed statements govern by way of a true-up, and your client holds audit rights over the calculation.
The one provision worth reading twice
The payment is the greater of fifty percent of free cash flow or the interest accruing on the note, and never more than seventy-five percent of free cash flow.
Without the interest floor, a share-of-cash-flow payment can fall below accruing interest in a weak year. The note would then negatively amortize and the balloon at maturity would exceed the price paid. The floor prevents that. The seventy-five percent limit prevents the floor from taking so much of a struggling business's cash flow that the business itself is put at risk, which would be the worse outcome for a secured creditor. Below that limit interest capitalizes, and it is disclosed in writing at the time rather than discovered at maturity.
Worked illustration
Price $8,000,000, note rate 5.0 percent, opening free cash flow $1,000,000 growing at five percent. Annualized for legibility; payments are monthly. The arithmetic scales linearly with principal.
The price here is a placeholder chosen for round arithmetic. It is not a valuation method, and no multiple of revenue, earnings, or cash flow is stated or implied anywhere on this site.
| Yr | Free cash flow | Payment | Interest | Principal | Balance |
|---|---|---|---|---|---|
| 1 | $1,000,000 | $500,000 | $400,000 | $100,000 | $7,900,000 |
| 5 | $1,215,506 | $607,753 | $370,440 | $237,313 | $7,171,487 |
| 7 | $1,340,096 | $670,048 | $344,596 | $325,452 | $6,566,469 |
| 10 | $1,551,328 | $775,664 | $288,104 | $487,560 | $5,274,516 |
Payments total $6,288,946 and the balloon is $5,274,516. If cash flow is flat instead, payments total $5,000,000 and the balloon rises to $6,742,211, since principal retires more slowly. The flat case therefore produces the larger nominal total, which is why nominal totals are a poor measure of what a seller receives and why we do not use them.
What it is worth
| Discount rate | Present value | Reading |
|---|---|---|
| 3 percent | $9,226,000 | Above the price. |
| 5 percent | $8,000,000 | Equal to the price. True by construction, since the note carries five percent. |
| 7 percent | $6,980,000 | Roughly $1.0M below the price. |
| 10 percent | $5,753,000 | Roughly $2.3M below the price. |
At your client's own cost of capital there is likely a gap, and we would rather put it in front of you than wait for you to find it. It is the price of not running the business for another decade and not having to find a buyer.
Compared to doing nothing
The comparison that decides these transactions is rarely against a cash offer. It is against the readiness path, or against keeping the business as it is.
| Alternative | Cash over ten years | Business at year ten | Owner's role |
|---|---|---|---|
| Keep operating it | $12,577,893 | Retained, grown | Full engagement, all risk |
| Keep it, hire a manager | Roughly $9.7M after management cost | Retained, grown | Hiring and supervising, still all risk |
| Annuity Sale | $8.0M present value at the note rate | Transferred | None |
| Keep it while disengaged | Roughly $8.0M on a five percent annual decline | Retained, worth materially less | Nominal, all risk |
Where this structure is the wrong answer
Against a healthy business whose owner still wants to run it, this structure loses on the arithmetic and there is nothing that rescues it. Your client keeps more cash and keeps the company. If that describes your client, stop here.
It also does not fit an owner who needs cash at closing, an owner with a live competitive process and real cash bids, or ownership spread across a group expecting conventional liquidity.
It fits the owner who has stopped driving the business, because the first row above quietly assumes performance continues while engagement stops. It fits the business that will not sell conventionally at a price the owner will accept.
Tax treatment
Installment reporting under section 453 spreads gain across the years payments are received rather than recognizing it at closing. Each payment carries interest taxed as ordinary income and principal taxed at capital gain rates. Where stated consideration lacks adequate interest, sections 483 and 1274 impute it.
One point stated rather than glossed, because materials of this kind commonly get it wrong. An installment obligation is income in respect of a decedent under section 691(a)(4), and section 1014(c) denies it a basis step-up. Heirs do not take the remaining note free of the deferred gain; they keep reporting it as payments arrive. Section 691(c) gives them a deduction for the federal estate tax attributable to that income, which is a real benefit and a smaller one. State treatment varies. Nothing here is tax advice.
What we do not do
We pay no transaction-based compensation for sourcing or introductions. That is a structural rule rather than a negotiating position, and we state it first rather than last. We do not act as an agent for either side, run a process, or ask an advisor to represent anyone. Nor do we ask you to introduce anyone on the strength of a document: if this looks plausible for someone in your book, the next step is a conversation in which you press on it directly.
Documents
- The Annuity Sale: A Structural Analysis for AdvisorsPDF · v1.1 · August 2026
- The Annuity Sale: For OwnersPDF · v2.0 · August 2026