Notable features of many M&A transactions include earn-outs, part sales and deferred considerations. But different deal structures have their own advantages – and disadvantages.
Adrian Benson, partner and head of corporate and M&A with Dillon Eustace, says there is “no one-size-fits-all” when it comes to structuring a merger or acquisition. “Both buyers and sellers typically consider what type of structure would be most beneficial and would be acceptable to each counterparty,” he says.
Every deal is different, agrees Mary Kiely, corporate partner with Eversheds Sutherland. “Whether you are sell side or buy side, understanding what the right deal structure is for you is key,” she says. “There are many different factors which influence deal structure, such as deal funding, the risk appetite of the parties and the regulatory landscape.”
The most straightforward deal structure, Kiely says, is where 100 per cent of the purchase price is paid upfront and the transaction signs and completes on the same day.
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“This is often regarded as seller-friendly because it delivers deal certainty and price certainty.” She notes, however, that achieving this “simplistic” deal structure is often out of the hands of the parties to the transaction. “Regulatory approvals, such as merger control consent, will often dictate deal timing while the availability of deal funding will often dictate payment terms,” she explains.
While sellers will typically want payment in full in cash on completion, Benson points out that this may not be possible for several reasons. “The buyer may have insufficient funds, perhaps the buyer wants an escrow or retention arrangement to cover warranty and indemnity claims or else the parties can’t agree on the target’s value,” he says. In these circumstances the seller may agree to a deferred or earn-out consideration mechanism. These can include completion accounts, earn-outs and anti-embarrassment protection.
Earn-outs and deferred consideration structures have become a frequent feature of deals in recent times. “Such structures facilitate greater risk allocation between the seller and the buyer,” says Kiely. “In an earn-out structure, the seller will only be paid if the target achieves certain agreed financial milestones, such as a revenue target, during an agreed time period – for example, three years. Earn-outs provide the buyer with comfort on valuation and protection against economic and other factors, but this structure will not work if the seller requires a clean exit.”
Sellers often favour the certainty of a deferred consideration structure over an earn-out structure – albeit provided the seller has confidence in the credit worthiness of the buyer, says Kiely. “Under a deferred consideration structure, the payments will typically be fixed in quantum but staged, providing the buyer with greater flexibility for deal funding and comfort that there is a ‘pot’ available for warranty claims.”
The sector of the target’s business may also influence how the purchase price is paid. “For example, deferred consideration structures, based on achieving certain milestone events, are relatively common in the renewable energy sector whereas sales-based earn-out structures are much more common in the consumer and retail sector,” Kiely explains.
Benson points out that one of the cons associated with this type of deal structure is that if the seller doesn’t receive the full amount upfront in cash, it may then need to fund its own transaction costs and potential tax liabilities out of its own resources.
“The seller also runs the risk of share value fluctuations or difficulty in exiting at a later date, say due to lack of a market in the shares in the case of a private company, or non-payment in the case of loan notes if the buyer’s financial position deteriorates post completion,” he notes.
A part sale structure is more commonly seen in management buyouts and private equity transactions, with private equity investment regularly structured as a part sale or roll-over. “Therefore, in addition to agreeing the terms of the sale, such transactions have the added complexity of negotiating the terms of a shareholders’ agreement,” Kiely says.
Benson says companies must weigh up which structure suits their business best. “They must consider whether the profile of the business being sold makes an earn-out appropriate, the tax implications for sellers of a particular deal structure, how a buyer can finance the purchase if it has insufficient cash of its own and, of course, the implications of financing with debt or equity – or both – for both buyer and seller.”
