Seller rollovers, earn-outs, part sales, deferred considerations and partial exits are standard features of many M&A deal structures, and each has its uses and attractions as well as drawbacks. But how do you know what’s best for you, particularly as times, and trends, are a-changing?
“There was a time when even the whisper of the terms ‘earn-out’ or ‘deferred consideration’ was a sure-fire way to send a deal negotiation to an early grave,” says Laura Kennedy, corporate partner at law firm A&L Goodbody.
That was the nature of what she calls the “seller-friendly” market that came to a thudding halt post-2021, when rising inflation and interest rates put deal dynamics to the test.
“No longer could investors rely on cheap debt for swift, high-multiple returns on investment. Instead, the post-2021 era brought a very different M&A market with elongated, ‘flexible’ deal processes, endless tyre-kicking and some might say hostile investment committee environments,” explains Kennedy.
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Yet challenging environments are often fertile breeding grounds for innovation and “While they may not be all that novel, ‘innovative’ deal structures have come back in vogue helping buyers – and their investment committees – to support investment strategies, bridge valuation gaps and, most importantly, get deals over the line,” she says.
There are lots to consider, including ‘straight holdbacks’, where a portion of the overall deal consideration is withheld by the buyer until a period of time has elapsed after completion. This is often done for the purpose of covering potential warranty claims during the claims period, typically up to 18 months, she explains.
Then there are more traditional earn-outs, deferred consideration structures tied to specific milestones. These milestones are generally aligned to those set out in the target company’s budget forecast, she says, and are required to be hit within a specified period after the deals completes.
“The other form of deal structure tool that we see private equity buyers use extremely effectively in order to ‘risk-share’ with the sell side is the ‘rollover’ mechanic,” says Kennedy.
“This is the requirement for certain senior executives in the target company, who also happen to be selling shareholders, to ‘rollover’ – in other words, reinvest – a portion of their sales proceeds into the target company so that they effectively become co-purchasers. This is one of the most effective tools a buyer can use because there is no greater incentive to drive the success of the company than putting the senior executives’ own money at risk.”
At a time where buyer investment strategies are being scrutinised more than ever before, deal structures like earn-outs and holdbacks offer protection to buyers. “It means that if the revenue targets forecasted in the company’s budget do not materialise, or some other unforeseen geopolitical event arises, the buyers have a natural hedge against overpaying for the asset,” she explains.
“From a seller perspective, deferred consideration and earn-out structures tend to be viewed negatively, particularly for sellers wanting a clean exit from the business. Sellers are going to be incentivised to stay with the business to make sure whatever metrics are required to be hit are in fact hit. This becomes more challenging if the sellers are not permitted to remain in situ for the duration of the earn-out period and the buyer and its accounting team are responsible for assessing whether or not certain milestones have been hit.”
It is a fraught area to which expert legal advice adds serious value. “Never more are the wordsmithing abilities of a lawyer required than in drafting with the greatest specificity the mechanics of an agreed earn-out or other deferred consideration structure,” she agrees.
“Any room for ambiguity has the capacity to leave the door open to differing interpretations and dispute.”
Hayes Solicitors works with clients ranging from private equity houses, family offices and private wealth funds to trade buyers making their first deal.
As such it has experience on both sides of the deal table.
“For sellers, we are working with tax advisers to put in place as positive a structure as we can, in order to mitigate risk,” says Ken Casey, a partner in Hayes Solicitors.
That includes ensuring clients are aware of the impact of beneficial elements of the tax code such as entrepreneurial and retirement reliefs.
It can also be about ensuring the seller understands the value of using a holding company as a strategic way to manage and potentially reduce capital gains tax.
There is, he says, growing interest in Irish firms from European investors, many of whom see Ireland as both a poster child for innovation and a conduit between the US and EU.
Regardless of who you are selling to, to achieve an efficient sale at the best price possible, some house keeping is in order.
Casey advises sellers to undertake a presale health check to ensure their share ownership integrity is intact, with no outstanding issues or overlooked gaps.
Understand the unique selling point of your business and be realistic about the value – if you are looking at comparators, make sure they truly are comparators, he urges.
If you are accepting or offering a deferred consideration, such as an earn-out, be aware of the challenges. “You will have different voices trying to manage the business while, for the buyer, you have to keep up the seller’s interest and momentum in the longer term,” he points out.
On the flip side, such deals will increase the price, allowing the buyer to pay more than they otherwise would have, he says.
