There are many factors that contribute to making a deal acceptable to both Buyer and Seller and one of the most important of these is deal structure. It can be a surprise to a Seller to learn that they will almost certainly not receive all of their money on the day of completion, but what constitutes a fair deferral and what is an unreasonable request to effectively buy the business with the vendor’s money?
Understanding the reason for the deferred consideration is a helpful starting point. It might simply be a question of affordability on the part of the Buyer, particularly if the balance sheet of the target business does not lend itself to asset based finance. Alternatively, if the sale is a share sale, there is an argument that an amount kept ‘behind the clock’ is a prudent safeguard by the Buyer against a breach of the more onerous warranties and indemnities that accompany a share sale. However, an element of deferred consideration is normally also present in asset sales and that is because the primary driver for a deferred element is, in reality, for the Buyer to mitigate risk associated with the purchase.
Nearly every aspect of a negotiated deal is ultimately a conversation about the allocation of risk between Buyer and Seller and the deferred consideration element is no different. This means that a buyer making a perceived riskier purchase will expect to have a greater proportion of deferred consideration and we find this is backed up empirically. The ‘norm’ for a ‘stable’ business in the current environment is 75% of the consideration on completion and 25% deferred. However, imagine if the business being bought were profitable but largely dependent on one contract, renewed every 2 years and coming up for renewal in 12 months. In this instance, deferring substantially more than 25% of the consideration, payable on the renewal of the contract would seem a reasonable and pragmatic position for a Buyer to take.
While the proportion of deferred consideration is typically on a sliding scale dependent on the risk profile of the purchase, the willingness of the Seller to accept the deferred element is also on a sliding scale, dependent on the level of security being offered on the deferred payment. A Seller will clearly view a deferred element held in an escrow account more favourably than the same deferred element with no security attached. Similarly, deferred but ‘certain’ is normally an easier pill for the vendor to swallow than deferred and based on the future performance of the business.
The conclusion is that a deferred element to a deal is now pretty much a fact of life – put another way, to expect everything up front will result in such a discounted offer that it will rarely be the right decision to accept. In the right circumstances, a performance related deferred element can work in favour of the Seller, with an open ended opportunity to share the ‘good news’ should the business outperform expectations under new stewardship.
At Anderson Shaw Corporate Finance we understand that negotiating on behalf of the Seller requires skill, experience and an open minded willingness to explore the whole landscape. A business will only sell if both Buyer and Seller feel they are getting a good deal and the reality is that often deferred consideration, in all its guises, is the most effective tool to deliver the best overall deal available to the Seller.