Unsurprisingly, one of the key factors in any transaction is the price and how this is structured.
Consideration
It might be that the agreement is simply that the purchaser will buy the business for a set price and that all of this will be received at completion. However, it is more likely that the structure will involve some amount of the purchase price being received at a later date. This amount might also be based on conditions being met or targets achieved and therefore subject to change.
This future consideration could be conditional on obtaining an important product approval or the renewal of a significant contract for example. It could be that an amount is held back in case of a claim under the warranties or that an amount will be paid a set period of time (perhaps a year) after completion based on the profits during that time.
If any form of deferred consideration is agreed, but most specifically in relation to an earn out or a structure which requires a certain event to take place, the sellers might insist on covenants from the buyer to take (or refrain from taking) certain actions during the period in which the deferred consideration has not yet been paid.
Another option which is not uncommon, especially in private equity transactions, is the opportunity for the sellers to take some of the price in the form of shares in the buyer. This could be an attractive option when considering the possibility of the return on these shares but the sellers should be careful to carry out their own due diligence on the buyer.
Provisions to consider
The agreement will set out how the purchase price will be paid. If it is not a pre-determined sum it will also need to include the calculations for the later payments to make sure that this will be decided as expected.
The parties will also need to consider whether there will be an adjustment to the purchase price if the working capital is not as predicted. For a deal such as this the parties will likely want to be very clear on how inventory will be accounted for and whether discounts or refunds are factored in.
The triggers for any deferred consideration need to be clear and unambiguous and include what is to happen if a particular event does not take place or takes place later than expected. The precise calculation for any sum that has not yet been determined should be included with the policies that will be used to assist with the calculations. It will also be important to decide who should do the calculation and what happens if there is a disagreement.
As mentioned above, when there is an element of deferred consideration that is contingent on future profits, for example, the sellers will want comfort that the buyer will not do something to jeopardise or reduce the amount of consideration due. This would include promises from the buyer not to remove assets or employees from the business during this time (for example in a reorganisation), that they will continue to run the business in its ordinary course and perhaps not to spend significant amounts in upgrading equipment or hiring new employees.
There might then also need to be provisions that deal with what is to happen if there is to be a change of control of the buyer during this period or if they would like to transfer the obligation to pay this consideration.
It’s important to remember that how the price is structured will be just as important as how much the offer is. The more that is deferred to be paid on a later date the more risk the sellers are taking. Security or escrow arrangements could be considered here to protect the sellers in the event the buyer faces financial difficulties, but in the end, the more cash received up front the lower the risk.
Speak with our expert Gail Vallis or our Corporate team here.
This article is part of our share sale series. Read our previous article in our series here.