Purchase Price
Category: Explaining the Deal; Risk Allocation
What is it?
This is what the buyer has agreed to pay for your business. Easy enough, right? Except there are many permutations of what this could look like, what it’s dependent on, when the payment comes, and how the number could change.
When does it matter?
The purchase price is obviously a deal driver, but the factors that determine how much you’re paid, when you get it, and how much you get to keep come to the forefront at different times.
The in-depth information on deal value can include various risk management tools. The use of a promissory note, earnout payments, set-offs, or escrow shifts the risk between parties and can ultimately change the value of the deal for both sides. Structural payment tools like these are often used to align the Seller’s interests with those of the Business and the Buyer, especially in situations where the Seller will remain actively involved in the company post-close. And, because these tools usually mitigate risk for the Buyer, they generally mean that the Seller will get more value from the structure than they would in an all-cash-at-close deal.
What to look out for?
From a seller’s standpoint: Do the math. Figure out how everything adds up. The most common mistake is that the payments don’t match the deal or that the tax accountants see that you should have paid something differently.
In a similar vein, make sure that the consideration is exactly what you expect it to be. Are you getting all cash? What’s the number? Is it all coming at closing? Is there some deferred element? If it’s not all cash, are you getting equity? What does the equity look like? Are you rolling over equity?
Here are some other things you might think about as a seller when reviewing the purchase price:
Deferred/Contingent Consideration
Earnout: “We agree that the overall value of this is $X, but I’m only going to pay you some portion at the closing because I’m concerned about the trajectory of your performance or want to make sure that I’m getting what I think I’m getting. In a certain amount of time, if you’ve achieved some agreed upon objectives, I’ll pay you the rest.”
In the event that you have part of this as part of the transaction, the conditions will be described here. If they’re really complicated, you may have a separate agreement.
Payment by promissory note: Part paid at closing, part paid in terms of a promissory note.
Escrow: (Most common; related to risk allocation) “I’ll pay you $50 million, but $5 million of that will go into an escrow account.” In the event that there is some post-closing liability, the Buyer will get that money out of the escrow rather than assuming they will be able to collect it directly.
Holdback: Same as an escrow, but happens at the lower end of the market and doesn’t include a third party. The buyer just keeps the holdback for ~12-18 months.
Deductions
Transaction expenses: The buyer wants to make sure you pay your bills. If you’re using an intermediary, the buyer wants that fee to come out of your proceeds so there’s no question. Same with legal fees.
Debt: Buyer wants to ensure that they’re not assuming any debt. Deduct from the purchase price and pay out directly to the bank what they owe.
Do you owe anybody else money: Bonuses? Equity-type plans? Paid off directly at the closing.