Corporate transactions
24 May 2010
Deal or No Deal
Corporate transactions are starting to move forward but the consideration dynamic seems to have changed.
Most company acquisitions now include a large component of earn out or deferred consideration.
Earn Out
The acquirer will agree with the vendor that additional monies will be paid for the company if it reaches agreed sales or profit targets. Usually these figures are agreed and contained within a business plan which is part of the signed contract for the purchase of the business.
Normally the purchaser will require significantly higher targets than those that would be set by the vendor’s management putting forward the argument that they will introduce the acquired company’s services to their much bigger client base.
What can the vendors do to protect themselves:
a) Do not agree to totally unrealistic future business targets.
b) Ensure that you maintain the right to examine all the future financial information relating to the company, so you can independently identify the integrity of reported key figures.
c) Most importantly have a clause in the Purchase Agreement detailing what support the purchaser will give post sale to help reach the business targets.
d) Then a further clause in the contract specifying the financial penalty if the purchaser falls short in their support to help the acquired company from meeting its post sale targets. The vendors will then be in a stronger bargaining position if targets are not met.
Deferred Consideration
This is different where the total consideration is agreed upon completion but payment of the full amount is deferred for a specific time. There is no argument about the amount, and the payment of the deferred balance is agreed upon a certain date.
The only concern is what happens if the vendors are not paid on the specified date.
What can the vendors do to protect themselves:
a) Ask the purchaser to pay you in loan notes that are guaranteed by a national bank. The bank then underwrites the transaction and they will pay you.
b) Ask for personal guarantees from the board of directors of the Acquirer.
c) Have a clause in the Purchase Agreement that if payment is not made you get the business back.
d) You still have the legal route to sue for breach of contract.
Making sure the earn out or deferred component of the sale is as low as possible is still the safest strategy and sometimes a slightly lower amount paid upon completion should be considered.