Parties, Price, Terms, Structure: Understanding Structured Offers
Any transaction will involve parties, price, and terms. When it comes to selling your business, what may be unfamiliar is structure. So, in the context of selling a business, let’s break down what each word means, and why structure can be an important problem solver.
The parties in a transaction are usually the buyer and seller. Sounds simple enough. But in significant financial transactions, sometimes the buyer is not really the buyer, or at least not the only one. Oftentimes, offers are made by multiple parties, with one or more parties writing equity checks alongside debt providers. As the seller, you can request sources, meaning a breakdown of where capital is coming from. If the buyer has committed funds, the answer should be straightforward (e.g. SEC filing of a fund, certified bank letter). However, if they do not have a committed fund or invest solely their own capital, the answer may be vague and involve a financial contingency, meaning that their offer is dependent on being able to raise the associated capital.
As an illustration, Permanent Equity operates committed funds and typically does not employ debt in our transactions. Therefore, our offers typically have no financial contingencies.
In a sale, the price people usually reference is the headline valuation, or enterprise value, of a business. When someone says, “I sold my business for $50 million,” that doesn’t necessarily mean they received $50 million in cash. It means that $50 million was the agreed upon valuation between the parties.
Most transactions are not for 100% of a business. If 100% of the interests are sold, that is a buyout. But even in a buyout, all proceeds are not necessarily paid at closing.
The terms are the details associated with a transaction. There are many, many types of terms in a deal, ranging from transition terms to reps & warranties and beyond. Structure specifically refers to when and under what condition certain payments are made, and it is a type of term.
Structure exists to solve a negotiation issue between buyer and seller on time, information, and/or confidence in the future. For example, a seller may have high confidence that the company will grow 25% next year, while the buyer (with less information) is more skeptical. Structure can be used – saying, “If X is achieved, then Y will be paid” – to bridge a confidence gap.
The most common forms of structure used to bridge such gaps are:
Cash at Close: Money paid at closing.
Rollover: The value of equity rolled forward by the seller (e.g., if the buyer purchases 80% of the equity interest, the seller is rolling over 20%).
Seller’s Note: A loan from the seller to the buyer, with a future repayment schedule and interest rate mutually agreed upon.
Earnout: A future payment to the seller, oftentimes tied to achievement of specific KPIs.
Preference: Post-close, a specific order in which distributions are made to shareholders.
Clawback: Money that can be “clawed back” from the seller in the event that something bad happens (e.g., a buyer may have a clawback clause that kicks in if the largest customer stops working with the company post-transaction).
Escrow: Money reserved in an escrow account, usually to cover a potential clawback or other transition concern between the buyer and seller.
Examples of Structured Offers
Let’s say a buyer makes an offer to purchase 80% of the equity interests in the seller’s company. Here are three examples of how that offer may be structured:
Offer A
$30M Enterprise Value =
$6M Rollover
$15M Cash at Close
$9M Seller Note
Offer B
$30M Enterprise Value =
$6M Rollover
$24M Cash at Close
$5M Annual Preference on Distributions
Offer C
$25M Enterprise Value =
$5M Rollover
$20M Cash at Close
$8M Earnout if the Company Achieves X Within 3 Years
Which offer is best? B offers the most cash upfront, but the value of the rollover may be diminished in the future if the preference can’t be satisfied. A offers a higher headline value than C, but C offers more cash upfront and overall, if the KPIs are achieved. The most honest answer is that the best deal is whatever works best for the parties involved. Structure exists to build bridges between perceived risk and perceived value.
As a seller, you will most likely be presented an offer. The choice is a thumbs-up, a thumbs-down, or a discussion about what perceived risks are embedded in the buyer’s offer and ways to build a bridge between what you wanted to see and the offer in hand. The buyer may or may not be receptive, but that discussion will serve you well in determining how others view your business. To have a productive discussion and make an informed decision, it’s helpful to know what different types of terms are available and how they function to build the right deal for you and the buyer.
For a deeper dive on purchase agreements, see Finding Middle Ground: Demystifying Deal Structure.
