Many times buyers and sellers are in agreement with all the terms of the transaction, except the price. The variance on price may seem to be a “deal killer”. Yet, if you resolve the price gap, both parties can move forward to complete the transaction.
Most sellers want an all-cash transaction. Sometimes partial seller financing is necessary in typical middle market company transactions. Sellers who demand all-cash deals typically receive a lower purchase price than if they would have had a different deal structure.
Even if a buyer is able to pay all-cash, they often want to structure a deal where the seller has left some portion of the price on the table. This can either be in the form of a note or an earnout. Deferring some of the owner’s payment from the transaction will provide leverage in the event that the owner has misrepresented the business. An earnout is a method to provide payment based on future performance. Buyers like to suggest that, if the business is as it is represented, there should be no problem with this type of payout. The seller’s response is that he or she knows the business is sound under his or her management. The seller does not know whether the buyer will be as successful in operating the business.
The owner has taken the business risk while owning the business; why would he or she continue to be at risk with someone else at the helm? There are circumstances in which an earnout can be useful in recognizing full value and completing a transaction. Here’s an example. Suppose that a company had spent three years and vast sums developing a new product. They had just launched the product at the time of a sale. Agree on a certain value for the current business. Then structure an earnout to compensate the owner for the effort and expense of developing the new product. Everyone wins under this scenario.
How To Bridge The Price Gap
- If the real estate was originally included in the deal, the seller may choose to rent the premise to the buyer rather than sell it outright. This will decrease the price of the transaction by the value of the real estate. The seller may choose to retain the title to certain machinery and equipment and lease it back to the buyer.
- The buyer can acquire less than 100% of the company initially and have the option to buy the remaining interest in the future.
- Create a subsidiary for the fastest growing portion of the business being acquired. The buyer and seller can then share 50/50 in the part of the business that was “spun-off” until the payoff of the original transaction.
- Structure a royalty based on revenue, gross margins, EBIT, or EBITDA. This is usually easier to structure than an earnout.
- Carve out certain assets of the sale, such as automobiles or non-business related real estate. This will reduce the actual purchase price.
The above suggestions will not solve all of the pricing gap problems. However, they may lead the participants in the necessary direction to resolve them. EBIT Associates has the ability to structure successful transactions that satisfy both buyer and seller. Structuring a deal requires an immense about of time, skill, and experience.