Valuation guide
Structuring the deal
As you consider the sale of your company, one of the most important issues you will need to consider is what types of deal structures are likely to be best for you.
All-cash deals are relatively rare and, in fact, if you are willing to stay with the company for a predetermined time frame, you may actually maximise the return on the sale of your business by not opting for all-cash. Every deal structure is unique to the seller and their individual goals and financial needs, so it is particularly important to approach the sale of your company with some flexibility.
Business sales, mergers and acquisitions are rarely structured all in cash. Tax and other considerations of the structure of the transaction can have an important effect on the overall value of the transaction to the principals. Each type of structure carries with it different tax consequences for the buyer and seller. Since tax law is constantly changing, it is important to seek suitable advice in determining the best way to structure the purchase or sale. This is for a number of reasons including tax, financing, buyer preference and maximisation of value.
Deals can be structured in many ways with some of the more common examples below;
- Cash
- Deferred Payments
- Retentions
- Performance related payments
- Earn Outs
- Elevator Deals
- Shares
- Mergers
Cash on Completion
“All Cash” on completion deals are less common in the current economic climate. Buyers are happy as they have immediate ownership and sellers are happy as they have a minimum risk on the payment. “All Cash” is ideal as a seller where the business is not dependant on you and you require an immediate exit. However, it may not be the best way to maximise the value. If the business is dependant on you or has other high risks associated, one key contract or supplier for example, it may not even be achievable as buyers seek to cover their handover risk.
Deferred Payment
Deferred Payments are where a percentage of the price is paid to the vendor on a fixed basis over a fixed period of time, usually with interest. The deferred part of the deal is effectively a vendor loan and is usually put in place to help the buyer finance the purchase, particularly if banks are unsupportive. It may also enable some of the price to be paid out on future profits. The purchase price is defined from the outset, a proportion of the price is payable on completion and the remainder is payable over a period of time.
Retention
Retentions are also a form of deferred payment. The idea is that the purchaser pays all the money on completion but retains a proportion, in an escrow account, in lieu of certain events. It may be just whilst the final net asset value of a company is calculated at completion, or in lieu of a contract being renewed. Retentions work well because sellers can see their money, but buyers do have a means of straight forward claw back in certain pre-defined eventualities where required.
Performance Related Payments (PRP)
An initial payment is made on completion and then secondary performance related payments are made subject to certain performance caveats. These are often used to help;
- The buyer manage risks and finance the deal through future profits
- The seller maximises the deal by linking it to future expected growth.
Earn Outs
These are effectively performance related payments (PRP) where the seller is expected to stay and work to achieve the PRP through that work on a service contract. The idea is that the vendor has a financial incentive to help make a success of the business or the larger organisation after sale.
An Earn-Out is a method of buying the business that helps bridge the gap between the positions of the buyer and seller with respect to price. An earn-out can be calculated as a percentage of sales, gross profit, net profit or other agreed figure.
Earn-outs do not preclude the payment (PRP) of a portion of the purchase price in cash or instalments. Rather, they are normally paid in addition to other forms of payment. As the payment of money to the seller under the provisions of the earn out is predicated on the performance of the business, it is important that the seller continue to operate the business through the period of the earn out.
Elevator Deals
Elevator deals are for ambitious sellers and can consequently be called “cash in some of your chips and keep playing” They provide a mechanism to link the purchase price of a business to its potential value or profits. An ongoing involvement in the business is required by the seller in order to drive and “elevate” the value and profitability going forward. By retaining shares in their business or by taking shares from the buyer, sellers have the potential to truly maximise the overall value of the transaction.
Shares
Some buyers and sellers will also offer and accept shares (usually a minority shareholding) in some transactions. Some buyers may also offer shares as a means to avoid using cash. These are in a way a form of deferred payment.
Mergers
Either party may seek a merger. This is a combination of two or more businesses on an equal footing that result in the creation of a new reporting entity. The shareholders of the combining entities mutually share the risks and rewards. Mergers are more likely to occur and are in fact more common in PLC’s where shareholders are less attached both directly and emotionally to the running of the business.