Jack Bull, 8 November 2023
When advising a purchaser on a share or asset purchase deal, one of the key considerations is what the purchase price should look like, how it should be paid and whether it is contingent on certain events happening after the completion date. From the Seller’s point of view, the best position would be for the whole purchase price to be paid on completion with no part of the price being contingent on future performance. The negotiation between the parties on this point is often extensive to find a solution that works for both sides.
Deferred Consideration is an umbrella term for any payments that are scheduled to be made after the completion date (when the assets or shares of a business are sold). There is however a big difference between deferred payments being made by instalments (a certain amount not contingent on future performance) and those that are subject to an earn-out formula (an uncertain amount contingent on future performance or agreed targets).
How the purchase price is structured is always a matter for negotiation and the party with the better bargaining strength is likely to control the payment terms.
Benefits for a Buyer
The Key benefits of utilising deferred consideration for a buyer include:
- Cash flow: if the purchase price can be structured over multiple payments over several years, the buyer can manage cash flow. If the deferred payments are subject to performance criteria such as a turnover target, client retention or key personnel retention, the buyer may not have to pay the full amount of the agreed price.
- Risk management. The deferred element of the purchase price offers some protection against the sellers being unable to pay any warranty or indemnity claims under the share purchase agreement or asset purchase agreement (as the case may be) after completion. The buyer’s position can be further strengthened by including an express right to set off warranty claims against the sellers against the balance of deferred consideration.
- Deal size and financing. The valuation of a target business may exceed what a buyer is able to pay upfront. As such, deferring an element of the purchase price enables buyers to enter larger transactions than would otherwise be feasible. Deferred consideration may also be preferable to financing a large transaction with a loan, given that interest does not typically accrue on the outstanding balance.
Risks for a Seller
The risk of deferred consideration for sellers is straightforward: the buyer may not have the funds to pay the instalments when they become due. This risk is more acute when the buyer acquires the target business by way of a company incorporated for the purpose of the acquisition, which on insolvency may not have sufficient assets to pay the deferred consideration to the sellers. This could be a devastating position for sellers of SMEs, particularly as the sale of a business is usually a primary retirement strategy.
Sellers of a business can therefore try to negotiate contractual protections to protect against the risk of failure to pay any deferred consideration. These must be reflected in the legal documentation and can include:
- Guarantees. If the buyer is a company, the sellers could seek a guarantee from its parent company, directors or beneficial owner(s). If a guarantee is provided and the buyer fails to pay the deferred consideration, the sellers will then have a remedy to seek recovery from a guarantor. Sellers must be aware, however, that the risk of non-payment remains if the guarantor is also unable to pay the guaranteed amount.
- Security over assets. Sellers may wish to seek security over certain assets of the buyer and/or target company. This could be a charge over property, shares or a key item of equipment. On enforcement, a charge entitles the holder to be paid from the sale proceeds of the charged asset(s) ahead of unsecured creditors of the same debtor.
- Payment acceleration. Sellers could also consider seeking a payment acceleration protection. Where there are multiple deferred consideration instalment dates, the sellers can demand immediate payment of all of the deferred balance if the buyer defaults on any given instalment.
Although there are inherent risks for a seller, it is a common for the sale of an SME business to include deferred consideration, particularly with a service business where the main asset is the client bank who are not tied into long contracts. Jack is a Trainee Solicitor in our Whiteladies Road office.
Jack is a trainee solicitor in our company and commercial team. To discuss how we can help with an acquisition or business sale, please contact us on 0117 9733 989 or by email to email@example.com