Published on March 28, 2023
Received an offer of acquisition? Congratulations! All those years spent building have finally paid off.
But before you high-five your co-founders, look beyond the purchase price to the components of the offer. Are you still getting a good deal? If you don’t understand those components, you might not realize their worth until it’s too late to do anything but walk away.
Evaluating an acquisition offer starts with your goals. You might already know what you need to gain financial freedom or start a new business. But the more flexible you are, the bigger your buyer pool, and the more likely you’ll close.
A buyer might not have much cash, for example, but might offer you stock or ask to pay in installments. Or they might tie payments to revenue or profit targets (reducing their risk but increasing yours).
An acquisition professional can help you navigate these conversations and structure a deal that meets your goals. But before you hire one, you’ll save time (and money on legal fees) by learning how each component of an offer works.
What Are the Components of an Acquisition Offer?
You can structure an acquisition offer in many different ways. Each component carries varying degrees of risk. Your job (or your advisor’s) is to negotiate a structure that offers the right balance of risk and reward that helps you achieve your goals.
As simple as that sounds, remember that you and the buyer want different things. You might need to compromise. Whatever you do, don’t hang on for that dream offer that might never come and let good ones pass you by. The best offer is sometimes the one in your hands.
Here’s an overview of the components you might encounter.
Cash: Cash is the simplest component. When the deal closes, you receive cash in your bank account. Cash is also the least risky (to you, not the buyer), but it’s not risk-free. Money laundering is one of the few issues you might encounter. You might sell your company only for a government agency to freeze your funds. Unlikely, but possible, so always vet your buyer first. Since cash is the most liquid asset, buyers might expect you to accept a lower price in exchange for them taking all the risk. Someone might offer you five million in cash, but if you were hoping for eight, you might need to close the gap with other components.
Seller’s Note (Seller Financing): A seller’s note is where you agree to receive a portion of the acquisition proceeds as debt repayments. The buyer adds your debt note to the startup’s capital stack, and you become, in effect, the startup’s creditor. Seller’s notes might be repayable over several years. You might also offer a year’s grace and a balloon payment at the end. It’s all negotiable. Of course, you have to trust the business will generate enough income to repay you after it changes hands. How much yearly payment should you expect? If the business goes bankrupt, you’ll probably get repaid when the owner sells the assets, but nothing is certain, so consider the risks. Seller notes offer lots of creative deal structures, but to minimize risk, speak to an investment banker or M&A advisor to determine a structure that ensures you walk away happy.
Earnout: An earnout is where you receive a portion of the purchase price when your startup meets certain performance milestones. The earnout might be tied to revenue or EBITDA, for example. Since you only get paid when the startup achieves specific goals, you take on more risk – especially if you leave the business – and must carefully vet the buyer’s capabilities. Like the other non-cash components on this list, earnouts help close the gap between your expectations and the buyer’s confidence in your startup. You might’ve built a convincing case for your projections, but the buyer still wants to mitigate risk. That said, you can negotiate: The targets, installments, earnout period, and so on are all on the table. First, you need to ensure your startup can hit the earnout targets otherwise you don’t get paid. If you walk away from your startup after acquisition, how can you guarantee your startup will hit those numbers? How would it feel to expect a million dollars every year for three years only to miss the earnout targets and get half that or nothing at all? It’s a big risk. Even if you do stay on in the business, you can’t guarantee it’ll hit those milestones. While you’ll still exercise some control over performance, you’re subject to a million external and internal factors that could derail growth or profits. Before you accept an earnout component to an offer, consult an M&A professional to discuss how each element of the earnout affects you.
Seller Rollover: Seller rollover is where you accept equity in the new entity. The buyer might say to you, “We’ll give you one million less in cash today but roll it over into the new entity. If the company grows as we expect, that one million will be worth between three and five million when we exit in five years. So, you’ll get a nice check at the end of it.” But without a crystal ball, you can’t predict anything with certainty. The company might never sell, or it might go bust. You either wait for years for the promised exit or your shares are worth nothing. Unless a public company acquires you, rollover isn’t that liquid, so the risks are higher. You’d have to be very confident in the buyer’s ability to grow the business. You might consider it if you believe in the potential growth of the company or group acquiring your company, and you’re okay with the risk of the unknown. I know of some sellers who rolled over two or three times, each time their company sold they took a percentage as rollover, compounding their returns over time. It’s risky but could make you very wealthy. Consider the price per share, how the buyer calculated that value, and the terms and conditions of those shares. Are your shares the same as everyone else’s or some new class that’s at the bottom of the capital structure? Lots to think about, so consult with an acquisition professional.
Seller Holdback: Seller holdback is where the buyer holds a portion of the purchase price back until a certain condition is met. This could be something like the outcome of litigation, working capital adjustments, or something else. Unlike earnouts, holdback doesn’t require hitting performance targets, but buyers might use it to compensate for accounting adjustments after closing or to settle their nerves on a certain aspect of the business. Before you agree to holdback, ensure the buyer agrees to deposit the holdback amount into an escrow account to protect both parties in the transaction. Buyers shouldn’t use seller holdback to squeeze the purchase price, either. If you’re unsure of whether you should agree to holdback, consult with an advisor.
Which Components Result in the Best Outcome?
Choosing which components to accept depends on what you want to achieve. Highest price? All cash? Fast sale? Lowest tax? Least risk?
You probably want all of these things (and more) to varying degrees and establishing your priorities in advance will help you field offers. You probably won’t get everything on your acquisition wishlist, but you might get most of it with a little forethought.
Start Exit Planning BEFORE You List: To minimize your tax liability, you need to speak to your tax advisor or wealth planner long before starting the selling process. An advisor might recommend you accept a seller’s note or earnout to reduce your tax liability, for example, and decisions like these will impact negotiations. Also, the more cash you ask for the less the buyer is likely to pay. Paying cash in advance before the startup has proven itself is risky. Also consider how the deal impacts your cofounders and investors who also expect a return on their investment (whether that’s time, effort, money, or all three). You then know how flexible you can be. Once you enter due diligence with a buyer, you lose your negotiating power since there are no other buyers competing for the deal. You might find it hard to back out of certain components without the acquisition failing. If you rush to sign final documents, it could cost you hundreds of thousands or even millions in tax obligations, so always start exit planning early.
Seek the Advice of an Acquisition Professional: I’ve only touched upon the implications of offer components in this article. If I were to advise you professionally, you’d learn so much more of the nuance behind these components. As I wrote before, you can get creative with your deal structure, so there’s usually enough flexibility to get what you want. Also, advisors like myself can give you an idea of the valuation ranges we see in the market. And if your startup is in that range, great, but what if it’s not? How could we get you to that range? Having an intermediary during early discussions keeps emotions in check, too. You don’t want to ruin the deal just because you’ve had a bad day. Acquisitions involve a lot of negotiation and having an advisor in your corner takes a lot of pressure off you. While you continue running your business, an investment banker, for example, can field inquiries, push a little harder on negotiations, and vet buyers on your behalf. You don’t want your startup’s performance to slip at such a critical time. Achieving a life-changing acquisition is well within your reach. With a little preparation and understanding of deal structures and components, you’ll know how to field inquiries once the first offers appear. Without that knowledge, you’re at the mercy of buyers who know more than you do, and you might leave money on the table.
*** The content is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional(s) before entering into any M&A transaction. ***
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Shawn Flynn is a Principal at Global Capital Markets, a premier middle-market investment bank with a global presence. Shawn has expertise in mergers and acquisitions, capital markets, financial restructuring, and secondaries. He speaks Mandarin and is the host of the award-winning Podcast The Silicon Valley Podcast. Connect with him on LinkedIn.
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