Structuring Deals: Making Sure You Receive 100% of the Proceeds

When selling a business, the structure of the deal is as crucial as the sale price itself. Understanding how and when you will receive the proceeds is key to ensuring you maximize your financial return and minimize risks. Let’s delve into the intricacies of deal structures and explore how to negotiate terms that safeguard your interests.

Introduction

Imagine being offered a billion dollars, but with the condition that you must swim across the English Channel with a 100-pound weight strapped to your legs. Clearly, such an offer is unrealistic and fraught with risks. Similarly, in business transactions, the structure of the deal can significantly impact the actual value received. It’s essential to thoroughly understand and negotiate the terms to ensure you receive the proceeds as agreed.

Structural Considerations

The Importance of Deal Structure

The value of a business sale is not just about the nominal offer but how the proceeds are structured. Ideally, receiving the full amount immediately at closing is the most favorable outcome. However, many deals involve some form of deferred payment, which introduces various risks. Let’s examine different deal structures, from the least to the most favorable, to understand their implications.

Earnings-Based Earnouts

Earnings-based earnouts are among the least favorable deal structures. In this arrangement, part of the payment is contingent upon the business’s future earnings. Once the business is sold, you lose control over its operations, and the new owner’s management style and cost structures can significantly impact earnings. This lack of control makes earnings-based earnouts highly unpredictable and risky. It’s best to avoid these structures whenever possible.

Revenue-Based Earnouts

Slightly better than earnings-based earnouts, revenue-based earnouts tie the deferred payment to the business’s future revenue. While revenue is more quantifiable than earnings, similar risks exist. Post-sale, the business may integrate into a larger entity, affecting revenue allocation. For instance, if your company is absorbed by a larger distributor, determining which sales contribute to your earnout can become complicated. To mitigate these risks, the terms must be clearly defined, or better yet, avoid revenue-based earnouts if possible.

Post-Transaction Consideration Flavors

Conversions

In some deals, payments depend on converting existing customers to a new model or system. This structure is complex as it relies on the acquirer’s ability to manage customer relationships effectively. If the new owner handles these relationships poorly, conversions might not happen as expected, reducing your payout. Successful deals with this structure require meticulously detailed plans outlining the conversion process, ensuring the new owner follows the established approach.

Client Retention

Client retention clauses link payment to retaining key clients post-transaction. This structure can be more favorable, especially if you remain involved in the business during the transition period. Retaining control over client relationships during this time can help ensure these conditions are met. However, the timeframe for client retention should be short to mitigate risks associated with new management potentially mishandling relationships.

Employment-Based Earnouts

Employment-based earnouts, where part of the payment is contingent on your continued employment for a specified period, offer a higher degree of control and predictability. These agreements should include well-defined roles and timelines to prevent new ownership from pushing you out prematurely. This structure allows you to influence the business’s success during the transition, aligning your continued involvement with the company’s stability.

Time-Based Payments

The most favorable structure, when immediate full payment isn’t possible, is time-based payments. These arrangements tie deferred payments to the simple passage of time rather than business performance. The primary risk here is the acquirer’s creditworthiness. Ensuring the buyer is financially stable and possibly securing collateral can mitigate this risk. Time-based payments offer the most predictability and security among deferred payment structures.

Key Considerations and Best Practices

Throughout these different structures, the common theme is control. The more control you retain over the variables affecting your payout, the better you can ensure you receive the proceeds as expected. Here are some best practices for negotiating deal structures:

1. Maximize Upfront Payment: Aim to receive as much of the payment as possible at closing to minimize risks.
2. Clearly Define Terms: Ensure any deferred payments are tied to well-defined, achievable conditions.
3. Retain Control: Where possible, retain some control over key aspects of the business or client relationships during the transition period.
4. Mitigate Risks: Use collateral or other assurances to secure deferred payments based on time.

Conclusion

In summary, structuring a deal to ensure you receive 100% of the proceeds involves careful negotiation and a deep understanding of the various deal structures. Immediate, risk-free capital is ideal, but if deferred payments are necessary, they should be structured to minimize risks and maximize predictability. By focusing on control and clearly defined terms, you can navigate the complexities of deal negotiations and secure a favorable outcome. Remember, the structure of your deal is just as important as the sale price—ensure you negotiate terms that protect your interests and provide certainty.